Strategising of Sezs: China Vis-À-Vis India

Strategising of SEZs: China vis-à-vis India

Aradhna AGGARWAL

1. Introduction

A growing number of countries are increasingly focusing upon special economic zones (SEZs) as engines of industrialization. According to ILO (2007), the number of SEZs increased from a mere 79 across 29 countries in 1975 to 3500 across 130 countries in 2006. Not only has the number of SEZs increased recently, but so have the varieties of SEZs. New varieties of zones have evolved and are subsumed within the category of SEZs. Several countries are upgrading their SEZs into mega-industrial clusters and commercial hubs with generous incentives to take advantage of their potential (Aggarwal, 2012). The usefulness of SEZs for the domestic economy however remains highly controversial. Evidence suggests that while SEZs may bring signifi cant benefi ts, they can also have negative welfare effects on the nation due to government revenue loss and distortions in the growth process. It has been argued that the zones have high maintenance costs; employ low-wage, unskilled female labor; offer an unstable employment base; generate little domestic added value; develop few labor or managerial skills; transfer little modern technology or know-how; have weak links to domestic manufacturers; and hence generate little net benefi ts. The net results can be signifi cantly negative with losses outweighing the positive effects. The SEZ literature is replete with studies on the factors crucial for the success of zones as engines of industrialization and growth (Madani, 1999; Kusago and Tzannatos, 1998; Aggarwal, 2012). A variety of micro, meso and macro climatic factors are believed to determine the success of SEZs. Some observers argue that the location matters while others consider that an export processing zone is more likely to succeed when monetary and fi scal policies are sound and stable, and private property and investment laws are clear. Still others underscore the need for liberalising the outside economy to ensure that the benefi ts of SEZs outweigh the costs. Little attention however has been paid to strategic approaches adopted by different countries in the conceptualisation, creation and promotion of SEZs; and their implications for the contribution of SEZs to the domestic economy. This study is an attempt to fi ll this gap. ‘Strategic approach’ is a broad framework that encompasses the vision, mission, objectives and strategies that are required to achieve the objectives. It is a perspective, a way of creating the roadmap to achieve the goals. More specifi cally, it is a plan to do things a certain way to achieve a desired outcome. Despite the central role it plays in the long-term success of a SEZ program, strategic approach is often ignored in the literature; too much focus remains on the policy related matters. A policy is a mere set of rules designed for the implementation of the strategy and hence is an element of the overall strategic approach. This paper analyses the SEZ programme of India and China with a particular focus on the strategic approaches adopted by these countries to exploit the SEZ-generated benefi ts, and examines their implications. Both these countries have a relatively long history of the programme. India established its fi rst Zone in 1965 while China in 1979. However they adopted different strategic approaches and traversed along divergent evolutionary trajectories to meet with varied success with their SEZ programme. It would be of interest to analyse the SEZ strategies and performance in these countries to better understand the links between SEZ perspective, strategy and performance. The rest of the chapter is organized into 4 Sections. Section 2 presents the theoretical

？？？？？ 13 discussion on the strategic approaches to the SEZ policy. Sections 3 and 4 analyse the SEZ strategies in China and India respectively and examine their impact on the contribution of SEZs to their economies. Finally, Section 5 concludes the analysis with policy implications.

2. Strategic approaches to SEZs: Theoretical discussion

Traditionally, SEZs are defi ned as ‘economic enclaves’ within which manufacturing for export occurs under virtual free trade. According to the neo classical (orthodox) theory they are established to offer duty free access to raw materials for export production to offset the anti- export bias of import substituting regimes which are characterised by anti-export bias in terms of high tariff barriers and distorted exchange rate regime. In this framework, SEZs are the second best solution to overall economic reforms and lose their signifi cance as countries implement country-wide systemic trade and macroeconomic and exchange rate reforms. An extended version of the theory (World Bank, 1992) considers SEZs as a policy means of achieving greater economic openness and growth. This theory however has little relevance in the current context. Recent experience shows that the considerable increase in the number SEZs across the world has followed the adoption of trade and economic reforms in the rest of the economy rather than preceded them. In that sense, in most countries they are the outcome of a liberalized regime. The heterodox school emerged in the 1980s explains the rationale of SEZs in open export oriented regimes (Baissac, 2003). According to this school of thought, the development of SEZs is the outcome of a move for export-oriented industrialization in developing countries. It argues that the countries that have adopted the model of “export oriented industrialization” (EOI) rely heavily on exports and FDI for rapid industrialisation. In general, export markets are characterized by fi erce competition, thin profi t margins and high volatility putting pressure on companies in developing countries to enhance their effi ciency, reduce production costs, and become internationally competitive. Domestic companies fi nd it diffi cult to compete in these markets due to inadequate production technology, ineffi cient management, and a lack of market access and marketing know-how. This packaging is provided by FDI. But the numerous market and production failures that the developing countries face due to a chronic lack of capable institutional actors affect their investment climate adversely by increasing both, production and transaction costs. This has dampening effects on FDI. Addressing these failures on economy would require time and resources due to socio-economic and political realities embedded in these economies. In this scenario, the establishment of industrial enclaves (SEZs) is an alternative second best policy tool by which these countries seek to address the structural deficiencies over limited geographical area and expedite the process of trade-based industrialization. SEZs offer numerous benefi ts (Madani, 1999; Aggarwal, 2006, among several others) including, tax incentives, provision of standard factories/plots at low rents with extended lease period, provision of infrastructure and utilities, single window clearance, simplifi ed procedures and relaxed labour laws, which reduce cost of doing business in the host country and offer a more conducive business environment to attract foreign direct investment, which would not otherwise have been forthcoming. Foreign direct investment (FDI) is believed to have catalytic effect by bringing positive spillovers to domestic fi rms in the host country, initiating a shift in the orientation of the domestic private sector toward export activities. Clearly, there has been evolution in the theoretical literature on SEZs. While traditional (orthodox) theories focus on the tax incentives offered by SEZs in an import substituting regime, heterodox economists suggest that SEZs offer an increased ease of doing business to promote exports and investment in an export oriented regime. Further, while the traditional approach fi nds SEZs useful in generating foreign exchange and providing employment, the

14 アジア研究 Vol. 57, No. 4, October 2011 latter approach views them as an instrument for expanding and modernizing the host economy through additional foreign investment/capital formation, technology transfer and technology spill-overs. These differences notwithstanding both the schools essentially treat SEZs as the second best solution to promote trade, directly a la orthodox approach and indirectly a la heterodox approach. We argue that the trade based second best solution approach to SEZs is erroneous. It has affected the design and performance of SEZs in most countries rather adversely. Zones are evolving over time and their characteristics have also been changing (FIAS, 2007; Meng, 2005). There is a need, therefore, to move to new theoretical paradigms to capture their potential benefi ts and consider them as part of the overall industrial policy of promoting cluster- based industrialisation. This study thus proposes to embed the establishment of SEZ within the economics of agglomeration in general and industrial clustering in particular. Although SEZs are concentrations of fi rms, the agglomeration economies associated with them are assumed to be of minor importance. They are being promoted as a mere trade enclaves; the relevance of localization economies and their role in promoting the competitive advantages of SEZs has gone unnoticed. The concept of industrial clusters was introduced and popularized by Porter in his book “Competitive advantages of nations”.1) Porter defi nes clusters as geographic concentrations of similar/ related fi rms that together create competitive advantages for member fi rms and regional and national economies (Porter, 1998). He roots and promotes his cluster concept with an overarching focus on “competitiveness” (of fi rms, industries, regions and nations) in a global economy, which makes his clusters trade-oriented. He identifi es exposure to foreign competition of fi rms and industries as both a driving factor and a distinctive feature of cluster formation and development. His clusters draw on Marshall’s industrial districts (Marshall, 1890).2) Since Marshallian industrial districts are based on the principle of comparative advantages, exposure to foreign competition happens to be a characteristic of neo-Marshallian industrial districts as well. They too are nodes of global networks (Amin and Thrift, 1992). The concept of SEZs thus bears clear commonalities with both Porterian clusters and Marshalian industrial districts. SEZs therefore need to be viewed as highly geographically concentrated government-promoted agglomerations of internationally competitive enterprise’ equipped with inherent advantages of effi cient infrastructure and quality services and a favorable business environment, few regulatory restrictions, and a minimum of red tape. Their advantages are, thus, rooted in localization economies arising out of knowledge spillovers, resource sharing, and labor pooling (Marshall, 1890). The specialization of activities within these clusters creates a pool of skilled labor; external economies in the form of lower transport and logistics costs; lower communications costs and (to the extent that utilities are shared) lower infrastructure costs; and knowledge spillovers. These external economies can have strong positive effects on investment infl ows in the fi rst place, a link that is overlooked in the SEZ literature (see, for example, Ng and Tuan, 2006, among others). Initial investment attracts more foreign and domestic fi rms due to localization economies and promotes further specialization, thus launching a process of “circular and cumulative causation” (Myrdal, 1957) or chain reactions (Kaldor, 1966). The cluster can further expand by the tendency of spin-offs and suppliers of both the clustered industry and related industries to locate near the zone. This simultaneous expansion of activities may be linked with the theory of big push (Lewis, 1954; Nurkse, 1952; Rosenstein and Rodan, 1943) or the concept of growth poles (Hirschman,1958). Whether it results in Rosenstein-Rodan type growth or Hirschman type growth, the process remains the same (Mathews, 2010). SEZs can, thus, act as self-reinforcing systems in which the clustered industries make up a mutually supporting whole with “benefi ts fl owing forward, backward, and horizontally” and have the capacity to expand given that “one competitive industry begets another” (Porter, 1990: 151). The concept of a cumulative and circular process

Strategising of SEZs: China vis-à-vis India 15 has been re-emphasized in the ‘new economic geography’ (NEG) theories wherein a concentration of manufacturing in one region can lead to a still larger concentration of manufacturing in that region and international trade assists this process (Fujita et al., 1999; Krugman, 1991). Apparently, SEZs which are agglomerations of highly competitive exporting fi rms provide impetus to investment in the rest of the host country. Geographic proximity of fi rms can also act as a major driving force for innovation, learning and knowledge spillovers and, in turn, promote competitiveness (Marshall, 1890; Porter, 1990). According to Porter, these processes can take place in all clusters, but ‘traded’ (export-oriented) clusters are more important than ‘non-traded’ clusters. It is widely recognized in the literature that openness to fl ows of knowledge, capital and people is an important condition for the cluster success and its competitiveness. The new economic geography theory carries this argument further. It argues that trade gains are higher when goods are subject to agglomeration economies because the concentration of world production in a single location allows greater exploitation of external economies and, hence, raises effi ciency. They can thus generate a process of development that is: a) accelerated; b) circular, in that one gain feeds off another; c) cumulative in its effects; d) self-reinforcing; e) capable of generating systemic gains through “increasing returns” (Mathews, 2010, for clusters); (f) is driven by innovations and knowledge spillovers; and (g) is effi cient and competitive. We thus identify two strategic approaches to establish SEZs: the trade based second best approach and the cluster approach. These have different implications for economic linkages and economic impact. From the perspective of the trade based second best approach, SEZs offer a platform for internationally mobile productive units; create an environment conducive to concentrated exchanges between domestic and foreign private sector actors within the zone; generate externalities through backward linkages upgrading those outside the zone; and initiate a shift in the orientation of the domestic private sector toward export activities. The strength of backward linkages depends on the government policies, level of sophistication of the wider domestic economy, the composition of economic activity within the zones and the ownership of fi rms, among others. The cluster approach however treats the SEZ as a typical cluster and indicates that the success of SEZs depends on their potential of activating synergetic forces that generate a process of circular and cumulative causation leading to decreasing costs of production and continuing concentration. The underlying principle is that (given interdependences between all factors in a social context) “any change in any one of the factors will cause changes in the others; these secondary changes are generally of a nature to support the initial change; through a process of interactions, where change in one factor continuously will be supported by reactions of the other factors, the whole system will have been given momentum to move in the direction of primary change, though much further” (Myrdal, 1956: 15–16). Thus, change becomes progressive and propagates itself in a cumulative way. An SEZ may fail to trigger this self-reinforcing mechanism if it is not embedded in the local economic milieu and ends up maintaining negligible linkages with the outside economy. Unless it represents a synergy with other actors in the region, it cannot initiate or augment the dynamics of a cumulative and circular process. In the proposed framework, therefore, SEZs should be strategically located in or around existing clusters, either natural or government-promoted. Alternatively, the government can plan large open SEZs or foster the development of clusters of several small SEZs. In that case, the objective should be to generate a critical mass of activity to attract more economic activity in the region. Clearly, there is need to distinguish between the trade based and cluster based approaches of SEZ development. They may have different implication for growth and call for different set of policies. In the rest of the analysis we focus on the SEZ approaches adopted in China and India and analyse their impact on SEZs’ performance.

16 アジア研究 Vol. 57, No. 4, October 2011 3. China: Success unmatched

The SEZs in China were launched in 1979 as part of Deng Xiaoping’s programme called ‘Four modernisations’ which aimed at the modernisation of agriculture, industry, science and technology, and national defense to ‘turn the country into a relatively advanced industrialized nation by the year 2000’ (McKenney, 1993). In Deng’s view, foreign investment and technology were needed to move China’s industrial base into the 21st century. Initially, four SEZs—Shenzhen, Zhuhai, Xiamen and Shantou were set up to ‘open up a window to the outside world (Chang, 1988). China evolved its own model of Special Economic Zones and discarded traditional closed processing zones. Unlike the latter, China’s SEZs are open industrial mega towns spread over several square kms. Shenzhen, for instance, spans nearly 2,000 square km; Shanghai’s Pudong district is 522 square km; and Hainan, 34,000 square km. Overall, Chinese SEZs are spread over more than 40,000 square km area. Finally, the choice of coastal areas was not merely to facilitate trade as is generally believed; cheap land, active participation by offi cials in these provinces, long tradition of trade and entrepreneurship in these regions and a greater likelihood of attracting nonresident Chinese investment to these areas were other important factors that factored into the choice of location (Lai, 2006). Chinese SEZs were thus a new generation zones and aimed at creating large clusters of highly competitive export industries in the locations where the outside investment climate was already conducive for spin-off activity. Nevertheless, these SEZs were not instant success. Haywood (2004) describes the special economic zone performance between 1979 and 1984 as somewhere ‘between disappointing to disastrous’. Money was fl owing freely from the central government and bureaucrats’ powers were unrestrained. This created opportunities for corruption in the bureaucracy. Smuggling of both people and goods was rampant (Haywood, 2004; Kung, 1985). Further, SEZs were predominated by Chinese investment; most foreign investment was in real estate, which led to a real estate boom. Uncontrolled immigration was occurring and labor agencies were taking huge commissions of 30 to 40%. The policy was widely criticized in China. Media, intelligentsia and general public, all, attacked them as ‘spiritual pollution’, rented territory, selling of nation, real estate proposition, and land grab (Kung, 1985). Interestingly, even the central government bureaucracy opposed the concept of SEZs because they eroded their power base in these regions. But neither the disastrous performance nor the criticism deterred the leadership, which decided not to scrap the zones but to learn from the errors. Offi cial delegations were sent to various countries to visit their SEZs. Better and more complete regulations were created. Several administrative reforms were introduced: the government was trimmed, corrupt offi cials were cracked down, huge money was pumped into infrastructure, and lucrative offers were made to skilled labour with spacious apartments within the zone. The SEZs, in particular, Shenzhen SEZ began to show signs of economic progress during the mid 1980s. Initial interest in the Shenzhen SEZ’s real estate market and tourist industry shifted to the development of production capacity. McKenney (1993) informs that in 1983, there were 60 establishments in Shenzhen SEZ employing 15,000 workers and it accounted for 69% of the industrial value and 82% of actual FDI of the city. Inspired by the initial success of SEZs, the government extended the SEZ sector by designating Hainan Province and the new Pudong districts in Shanghai as the fi fth and Sixth SEZs in 1988 and 1990 respectively. The Newly Developed Area of Tianjin Binhai was authorized as the seventh SEZ in 2006. All these seven SEZs will be referred to as city-SEZs in the rest of the text. In addition, the government established a myriad of zones, as follows.

Economic and Technological Development zones: At the beginning of 1984, China decided to establish economic and technological development zones (Hereinafter referred to ETDZ).

Strategising of SEZs: China vis-à-vis India 17 They were conceptualised as relatively small areas of land carved up within cities, and focused on attracting mainly the high-tech industry by offering attractive hard and soft investment environment. They are set up in highly developed areas near existing industrial clusters with good industrial foundation and convenient communication. To offer single window governance, the government has awarded economic managing right, which is equal to that of local government, to management committee of Economic-Technological Development Area. From 1984 to 1988, 14 ETDZs were established, all in the coastal cities. In 1992 and 1993, eighteen other national ETDZs were established and ﬁ nally, from 2000 to 2002, the government decided to build the third group in the rest of the provinces taking the total number of ETDZs to 49. To date, there are 54 national-level ETDZ, of which, 33 are in eastern coastal regions; the rest are in Middle West regions. In addition, hundreds of provincial and municipal ETDZs have been established all over China. The total area of these 54 economic and technological development zones is about 400 sq.km. equal to 0.004% of the total area of China (Herrle, 2005). Initially, these clusters were set up for attracting the foreign capital though the present positioning, targets and investment subjects are no longer restrained by the objective of attracting the foreign funds.

National Hi-Tech Industrial Development Zones: In 1998, the government started establishing National Hi-Tech Industrial Development Zones (HIDZ) under the ‘Torch Plan’ to promote domestic R&D capabilities. These are established for purposes of promoting local new/high tech industries oriented to both domestic and overseas markets and based on China’s local scientiﬁ c and technological strength. Currently, there are 53 State Council approved HIDZs, located primarily in the vicinity of ETDZs.

National Border and Economic Cooperation Zones: In 1992, the government introduced another innovative concept of National Border and Economic Cooperation Zones (BECZ). The BECZ (Kudo, 2009) is the area to develop frontier trade and carry out processing for re-exports along the border, exploiting cross country complementarities in resources. The objective is to develop trade, economy and good relationship with the neighbouring countries. They also play positive roles in promoting the economy of the backward border areas. The State Council has approved 14 BECZs since 1992.

Export Processing Zones: In April 2000, traditional zones of closed industrial estate variety were launched within the existing ETDZs and HIDZs. These are supervised by the Customs. There are 15 such zones set up within ETDZs and HIDZs.

National Tourist and Holiday Resort (THR): In order to exploit rich tourist resources and speed up the tourist industry, the State Council decided to choose the regions with ripe conditions as National Tourist and Holiday Resort (THR), where the enterprises and the tourist equipment and projects by foreign businessmen are encouraged. To date, there are 11 national holiday and tourist resorts by the approval of the State Council.

Taiwanese Investment Zones: In 1989, three ‘Taiwanese Investment Zones’ (TIZ) were approved in Fujian province by the State Council to encourage Taiwanese investment in China. The fourth one was set up in the same province in December, 1992. To date, four Taiwanese Investment Zone are operating, all in the Fujian province.

National Agriculture High-Tech Industry Demonstration Zone: In 1997, a National Agriculture High-Tech Industry Demonstration Zone (AHIDZ) was founded, aiming to radically develop the agriculture. Up till now, there is only one national grade agriculture high-

18 アジア研究 Vol. 57, No. 4, October 2011 tech industry demonstration zone in China located near Xian, Shaanxi Province.

Free Trade Zone (FTZ): It is a trade oriented zone for international trade and bonded operations with bonded warehouses and processing for re-export. Presently, 13 free trade zones in China are in operation. China has also set up more than 10 Bonded Zones (BZ) in SEZs and coastal cities. Six of them were turned into bonded Logistics Parks in 2004. China thus has continuously been expanding SEZ sector both vertically and horizontally, as a key element of its industrial strategy since 1978. It introduced ETDZs as early as in 1984, which were followed by several other types of zones. Large city-SEZs are set up as open clusters while smaller SEZs (ETDZs and HIIDZs) are being promoted in industrially developed areas in the proximity of existing clusters/estates/zones. China’s manufacturing landscape is characterized by a large number of industrial clusters. As part of the industrial-cluster strategy, a variety of zones are being located in the proximity of each other and of other industrial clusters to augment and reinforce each other (Kim and Zhang, 2008). By 2007, 300 of 326 municipalities had 1346 zones (Wang, 2009). Zones are being developed not only by the national, provincial, or municipal level government but also in the private sector. The success of SEZs and other development zones in China has been phenomenal. The share of the overall SEZ sector in GDP, industry value added, FDI, exports, and even tax revenue increased continuously over the period since 1979 (Ministry of Commerce, China website). In 2006, their share in real GDP was estimated to be 18.5% which increased further to 21.8% in 2007. They also accounted for 46% of the total FDI infl ows which amounted to 74.8 billion in 2007. Their share in total exports went up to 60% and they absorbed 4% of national and 10% of urban employment (Zheng, 2010). This made up the employment of 30 million people in this sector alone. Of all the SEZs, Shenzhen remained the largest SEZ which accounted for over 77% of the total exports of 218 billion produced by fi ve city-SEZs. In 2009, the GDP of 54 ETDZs alone was 1.712 trillion RMB, occupying 5.3% of total GDP of China. Their share in exports was around 16%. They accounted for 22.5% of total FDI and 5% of government tax revenue. Further, the government policy of promoting different varieties of zones and locating them in the proximity of the existing industrial clusters ensured the integration of local supply chain networks with global value chains to upgrade them, in turn. Kim and Zhang (2008) illustrate this point excellently by examining how the supplier–buyer linkages between foreign invested enterprises (FIEs) in the ETDZs of Qingdao and local fi rms in the existing clusters of that region drove the development of a successful electronic industry cluster around the zone. An industrial cluster of electronic plants emerged in Qingdao during 1966 to 1969. A turning point in its development process came when two ETDZs were set up in proximity, one in 1984 and another in 1992. These ETDZs attracted several foreign fi rms to the region. While the local fi rms remained the leaders, foreign fi rms got into contract with them for the supply of components, instantly inserting them into the global value chains which they had developed. This changed the structure of supply chains in the region. Knowledge started fl owing through these chains and pushed local fi rms into improving their own technological capabilities. This contributed to the emergence of a highly sophisticated electronics industry in the region. Evidence suggests that the SEZ sector has also played an important role in promoting and strengthening technological capabilities of the country. According to Zheng (2010), in 2007, the HIDZs accounted for almost half of the total high tech industries; almost half of high tech output and one third of high tech exports of the country. They had 1.2 million of R&D personnel and registered 50,000 patents which were more than 70% of total patents registered by local industries. The ETDZs also accounted for one third of total high tech exports. The early city-SEZs have also upgraded in terms of the technology content. As late as 1991, only 2.8% of the Shenzhen’s manufactured exports were high-tech. By 2004 they amounted to $30.6

Strategising of SEZs: China vis-à-vis India 19 billion and accounted for 51.2% of the manufactured exports (Li, 2006). By 2007, in all city- SEZs taken together, over 40% of the total industrial output was from high tech industries (Zheng, 2010). Fu and Gao (2007) have shown that the ETDZs have been playing an important role in employment generation and human capital formation, as well. They have been incurring large expenditures to support education and training. In 2005, the ETDZs used 6.69% of all their expenditure to support related education and training; this was 4.24 billion Yuan per year. The Central China’s 10 zones spent 8.8% of their expenditures on education, which on average was nearly three times of China’s public ﬁ nance. They also show that the 32 eastern zones share 73.8% of all education expenditure incurred in the region. They found a positive correlation between the number of provincial Development Zones and GDP per capita concluding that the provincial development zones are also engines of the regional economy of China. Wang (2009) uses experimental designs to show that having Special Economic Zone status increases total productivity growth by 0.6% points.

4. SEZs in India: Landed before they could take off

In India, the process of industrial growth was initiated as early as in 1948, when the government announced its fi rst Industrial Policy Resolution, IPR 1948. The centerpiece of the development strategy was the promotion of import-substitution based industrialization with a particular emphasis placed on the basic and heavy industries. The country, however, faced a severe foreign exchange crisis in the early 1960s due to multiple failures such as, the failure of agriculture, growing imports, and two border confl icts. To promote exports, several fi scal incentives were offered to exporters. In 1965, the government set up Asia’s fi rst export processing zone (EPZ) in Kandla, as part of these programs. Since EPZs were viewed merely as a tool for offering fi scal incentives for export promotion, the programme was not supported by any legislation or administrative infrastructure (Aggarwal, 2004; Kundra, 2000). The fi rst zone was set up in Kandla as early as in 1965. It was followed by the Santacruz Export Processing Zone which came into operation in 1973. The government set up fi ve more zones during the late 1980s. These were at Noida (Uttar Pradesh), Falta (West Bengal), Cochin (Kerala), Chennai (Tamil Nadu) and Visakhapatnam (Andhra Pradesh). These were geographically closed small industrial estates3) and were located in port areas (with one exception). Thus unlike China, the EPZ programme of India was driven by the traditional trade based second best approach. Further, these zones were subjected to numerous controls and regulations to prevent misuse of incentives by fi rms. In 1991, a massive dose of liberalization was administered in the Indian economy. In this context, wide-ranging measures were initiated by the government for revamping and restructuring EPZs also (Aggarwal, 2004). The focus had been on improving investment climate by delegating powers to zone authorities, providing additional fi scal incentives, simplifying policy provisions and providing greater facilities with the objective of improving investment climate in these zones. A major shift in approach and policy was introduced, when the government motivated by the success of Chinese SEZs, launched a new scheme of Special Economic Zones (SEZs) in 2000. The main difference between the SEZ and the EPZ was that the former was conceived as an integrated township with fully-developed, world-class infrastructure, whereas the EPZ was just an industrial enclave. Further, while EPZs were set up mainly by the central government, SEZs were permitted to be set up in the public, private, or joint sectors or by the state governments or any of their agencies. Several incentives, both fi scal and non-fi scal, were extended to the units operating in SEZs and measures were adopted to improve the quality of governance of the zones. However, the policy did not motivate private investors into action in a signifi cant way

20 アジア研究 Vol. 57, No. 4, October 2011 and eventually, all the existing eight EPZs were converted into SEZs. To provide a signifi cant ‘push’ to the policy, a comprehensive SEZ Act was promulgated in 2005. The Act became operative w.e.f. February 2006 when SEZ rules were also fi nalized. With the introduction of this Act EPZs ceased to exist while the scope and coverage of the SEZ scheme was enlarged. Under the Act, SEZs encompass a wide variety of export oriented zones such as single enterprise zones, sector specifi c zones, multiproduct zones with large townships and logistics oriented free trade zones. A wide variety of economic activities has been permitted in SEZs including services, manufacturing, trading, re-engineering and re- conditioning. The principal objective of the policy is to promote economic activity. The policy is not accompanied by vision, mission statement or roadmap to achieve the objectives. However, a major departure from the earlier approach is that it seeks to promote economic activity unlike EPZs which aimed at promoting trade. As a result, it does not regulate the location of SEZs, allowing market forces to determine where they should be located. During our fi eld visits across nine SEZ-active states,4) we observed that the market forces have shaped the SEZ location strategically in such a way that SEZs can play an important role in promoting cluster based industrialization in the country. The strategies adopted in the establishment of SEZs are as under.

Augmenting existing industrial clusters and industrial estates: A large number of SEZs are being promoted within existing clusters and industrial estates to augment and reinforce them. Many private SEZs are coming up in or around natural clusters or industrial complexes. Some state governments are also focusing on natural clusters and/ or existing industrial estates. The state government of Gujarat, for instance, has identiﬁ ed six regions that have already acquired industrial capabilities. Most SEZs are located in these regions to revitalize their core competencies and transform them into internationally competitive hubs by generating positive synergies between them. These are Ahmedabad (pharmaceuticals and textiles), Gandhinagar (information technology), Bharuch (chemicals), Vodadara (engineering), Jamnagar (petrochemicals), and Kutchh (heavy metals and logistics). Most of them (except Jamnagar and Gandhinagar) are natural clusters and both the state government and private sector developers have focused their efforts in these regions. Uttar Pradesh, Haryana, Punjab and Rajasthan seem to have adopted a similar strategy. Most SEZs in Uttar Pradesh and Haryana are in the information technology (IT) sector and are clustered in the existing IT hubs of Noida and Gurgaon. The state government of Uttar Pradesh has been promoteing two handicrafts SEZs in the natural clusters of Moradabad and Bhadohi; other state-promoted SEZs are in the industrial town of Kanpur. The Rajasthan government’s handicraft SEZs are in Jodhpur and the gems and jewelry SEZ in Jaipur; and Kerala’s food park and animation and gaming SEZs are carved out of the existing industrial estates. Several IT SEZs in Kerala are situated in or around the upcoming IT hubs of Kochi and Thiruvananthapuram and will reinforce them further. In Andhra Pradesh, also, many IT-based private SEZs are clustered near the IT hub of Hyderabad. In Maharashtra, most private SEZs are being set up in the industrially developed belt of the State, namely, Nashik–Pune–Mumbai. This strategy is likely to augment the inward-looking clusters/estates by creating opportunities for mutual learning, and innovation with the presence of outward-looking clusters in the close proximity. In today’s increasingly knowledge-intensive and globalised world, inward-looking clusters and industrial estates face serious challenges in terms of technology ﬂ ows, skills, environment, and quality control. The strategy of situating SEZs in and around them will create synergies and enhance regional agglomeration economies. The plan is to synthesize the setting up of SEZs with the development of industrial corridors and national investment and manufacturing zones (NIMZs). Several SEZs are projected to be located in investment regions, industrial hubs, and multi-model logistic hubs planned along the upcoming

Strategising of SEZs: China vis-à-vis India 21 Delhi–Mumbai industrial corridor. Each hub is to have world-class infrastructure, business centers, transport facilities, and good connectivity. SEZs are, thus, expected to beneﬁ t from these industrial nodes and, in turn, are expected to reinforce them.

Promoting new clusters through SEZs: An alternative strategy is to promote new industries by creating several small SEZs clustered in a region and reinforcing them by developing industrial estates in the proximity. The Andhra Pradesh government, for instance, has adopted this strategy as a route to industrial diversifi cation. New industries such as gems and jewelry, bio-tech, engineering, sports shoes and high end pharmaceuticals are being implanted by promoting large-scale production facilities through SEZs. Following a similar strategy, the Tamil Nadu government is using SEZs to move up the value chain in industrial production. It is promoting ‘Industrial Corridors of Excellence’ using SEZs to kick-start their development. In the fi rst phase, the Chennai–Manali–Ennore and the Chengalpattu–Sriperumbudur–Ranipet corridors will be developed with several SEZs clustered in this belt supported by industrial and IT parks, R&D institutions, universities, and social infrastructure like housing, healthcare and schools. This will be followed by the Madurai–Thoothukkudi and Coimbatore–Salem corridors. The Maharashtra government has also taken up large ambitious projects in manufacturing and infrastructure development in the industrially backward districts of Nagpur, Jalna, Nanded, Latur, Amravati, and Akola, among others. The state agency has played a signifi cant role in promoting industrialization in these regions, with 19 projects being developed directly by it. Interestingly, some private sector zones have also followed this pattern. Several private sector IT SEZs are coming up in Gandhinagar (Gujarat), Mohali (Punjab) and Jaipur (Rajasthan) to exploit the locational advantage of the skilled human capital in these regions. They are likely to implant the IT industry in these regions.

Promoting integrated industrial parks: Localizing global value chains: Large original brand manufacturing (OBM) companies, such as Nokia, Suzlon, Gitanjali, and Uniparts have been promoting integrated parks to cut the cost of logistics. They are using SEZs to attract upstream and downstream links in the global value chain within an SEZ and forge an industrial chain by creating all the necessary backward and forward linkages of the fi rms. This process of localization of international chains enhances industrial effi ciency by reducing transport and inventory costs and ensures all the advantages of vertical integration. Apparently, there has been a shift from the ‘trade based second best solution’ in SEZ strategy to ‘cluster based’ SEZ strategy. Interestingly, this shift is not strategically planned as in China but is guided by the market. Efforts are directed at locating SEZs close to existing clusters/ industrial estates, or clustering them in one location, or creating large-scale integrated production facilities through them. This is expected to create synergies between sectors looking at the domestic market and outward-looking SEZs, and between various SEZs within the same region. These synergies, drawing on both local production systems and global resources, would enhance regional competitiveness. The passage of the SEZ act invoked unprecedented interest among private investors to develop SEZs in the initial stages. As on 18 November 2010, 580 new SEZs across 23 states were formally approved, with 367 of them across 16 states already notifi ed. There has been phenomenal increase in SEZ investment, employment and exports. Investment: During the fi rst phase of their development, India’s zones had been dominated by domestic investment. Total investment in seven EPZs in 1998 stood at a mere $407 million, generating a miniscule 0.33 percent of the total manufacturing investment in that year. During the period 1965–2000, only 8 export processing zones were set up across 7 states, occupying an area of 2521 acres. Between 2000 and 2005, 11 new EPZs were set up. But most these zones were the result of State government initiatives; the policy did not induce private investment in

22 アジア研究 Vol. 57, No. 4, October 2011 SEZs. In February 2006 (40 years after the fi rst EPZ was set up in Kandla), total investment stood at $888 million. Within less than fi ve years of the SEZ Act, by November 2010, investment was staggering at $39 billion (Table 1). Two caveats need mention here. One, this investment includes investment in land and infrastructure development and hence cannot be compared with SEZ investment in other countries. Two, over 85 percent of the total investment is from domestic sources. Employment: The total (direct) SEZ employment stood at 81371 in 2000. It increased to 134,704 by February 2006. Within 5 years of the new SEZ Act, the number increased to 620,824. Exports: Average annual exports increased from $0.5 million during 1966–70 to $1.988 billion during 2000–2003. The share of erstwhile EPZs in national exports peaked in 1986 when it reached 5 percent of manufacturing exports. But most EPZ exports were directed to the USSR and other East European countries during this period because of protected export markets offered to Indian fi rms under the umbrella of bilateral trade arrangements with these countries (Kumar, 1989). After the collapse of the USSR, exports from EPZs declined sharply. In the late 1980s however four more EPZs became operational which pushed EPZ exports up and in the 1990s EPZ exports grew again and slowly reached 5.2 per cent. This was marginally higher than the previous peak. Table 1 reveals that the enactment of the SEZ policy provided a major push to SEZs’ export performance. Figure 1 indicates that in 2007–08, the average annual growth rate of physical exports (outside India) zoomed to over 100 per cent. It dropped to 32 percent in the recession year 2008–09 but to pick up again to over 100 per cent. Since 2006–07, SEZ exports have been rising much faster than the domestic tariff area exports. As a result, in 2009–10, the share of SEZs in total national exports stood at over 17%. Table 2 shows that the operational newly notifi ed SEZs accounted for 53.4% of the total SEZ

Table 1 Direct employment, investment and exports in Special Economic Zones: Feb. 10, 2006 and Nov. 30, 2010 Employment Investment Exports Feb., 2006 2010 2006 2010 February, 2006 2010 (bn) (bn) (bn) (bn) Central government 158197 205395 33.51 70.68 194.23 580.70 Transition phase 20566 63080 16.08 73.38 7.024 447.29 Newly notified. – 352349 – 1617.43 – 1179.46 Total 129,704 620824 49.5 1761.49 201.25 2207.72 Source: Based on the Ministry of Commerce, Indian Government database.

Figure 1 Annual growth rates of SEZ exports and total national exports*: 1992–93 to 2009–10

*: Total national exports are inclusive of service exports. Source: Calculations based data from the Ministry of Commerce and Reserve Bank of India.

Strategising of SEZs: China vis-à-vis India 23 exports in 2009–10. Further, physical exports accounted for 87% of the total SEZ production. The share of deemed exports and DTA sales had been as small as 5.5% and 7.5% respectively. Finally, notwithstanding the fact that IT zones have far outnumbered other zones, manufacturing accounted for almost 50% of their total physical exports in 2008–09; its share increased to over 77% in 2009–10. Further, while in the ﬁ rst phase (1965–2005) zones were dominated by labour intensive activities, industries of different generations co-exist in them since 2005 (Figure 2). While Apache in Andhra Pradesh, Cheyyar in Tamil Nadu, Brandix in Andhra Pradesh, and Apparel Park in Gujarat are the prominent examples of labor-intensive low-tech SEZs; Nokia SEZ, SIPCOT high tech SEZ, Flextronics and Velankani SEZ all in Tamil Nadu; and Moser Baer SEZ in UP among many others, are high tech SEZs. In addition, there are several IT, auto components, electronic components, pharmaceutical, and metal fabrication-based skill intensive SEZs. It is expected that low tech SEZs would generate employment while high-tech SEZs would produce dynamic externalities for creating new paradigms and industries. SEZs can thus catalyse economic activity simultaneously in many sectors and can create conditions for self sustaining industrialization if they offer an attractive package to investors, other things remaining the same.

Table 2 Export performance of SEZs: Type-wise disaggregated analysis 2009–10 (%) Share in physical Composition of SEZ production by sector (%) exports Physical Deemed Total SEZs IT/ITeS Trading Manufacturing DTA sales exports exports Production Central 26.3 5.03 5.91 84.19 95.13 0.78 4.08 100 Government Set up between 20.3 5.45 0.01 78.52 83.98 3.23 12.80 100 2000–05 Newly notified 53.4 27.44 1.47 55.59 84.50 8.41 7.09 100 Overall 100.0 17.44 2.23 67.28 86.95 5.49 7.56 100 Source: Ministry of Commerce.

Figure 2 Sectoral composition of notified SEZs as on September 2010

Source: Ministry of Commerce, India.

24 アジア研究 Vol. 57, No. 4, October 2011 Apparently, the SEZ policy has made useful contribution to investment and exports in the initial phases. The erstwhile EPZs could not forge strong linkages with the rest of the economy due to their small size, isolated locations near ports and tight government regulations on transactions between domestic and EPZ units. The rules for domestic procurement, subcontracting and domestic sales had been highly rigid to prevent misuse of the fi scal incentives offered to EPZ units. There were success stories of learning- by -exporting for EPZ manufacturing units which had a spillover effect on the economy, as reported in Aggarwal (2006). But nonetheless overall gains were not substantial and could not become visible. Most zones failed to make an impact because of poor locations, and the absence of a well-designed policy framework within which EPZs could be used strategically. One would expect that the new SEZs succeed in forging these linkages by reinforcing existing clusters/ promoting new ones due to their strategic locations. The SEZ policy has however been caught in a country- wide controversy due to land acquisition (Aggarwal, 2006). A massive intellectual support to the agitation against SEZs has come from the media, activists, and academia, both the right and left wings. Political parties also exploited the upsurge against land acquisition to target the government. The government itself appears a house divided. State governments have been directed not to acquire land for SEZs. Many states have adopted the policy of ‘go slow’. Furthermore, the Finance Ministry has expressed serious apprehensions on the revenue outgo due to tax exemptions offered in SEZs. In September 2006 the Reserve Bank of India directed the banks not to treat SEZs as infrastructure projects but as real estate development activity. This not only raised the cost of debt but also prohibited SEZ developers to go for external commercial borrowings. The order was rescinded in September 2009. These controversies have sent wrong signals across the world regarding the sincerity of the government with respect to its policy and discouraged both local and foreign investors. In response to these controversies, the government has diluted not only the policy but also its support to SEZ investors. This in turn has affected the investors’ confi dence badly. The lack of cooperation from state governments has also become a matter of concern. Though the SEZ policy has been in effect since February 2006, state laws have not been amended suitably. This provides a loophole in the system and is a major roadblock for the entrepreneurs to take advantage of SEZ benefi ts. Indeed they have registered an impressive growth in employment and investment; yet, their performance has been much below expectations for all these reasons. Five observations could be made (Aggarwal, 2012). First, as of now, less than two third of the approved zones have been notifi ed. Of them, only one-third are functional. Second, of the 20 states that have their own notifi ed SEZ, 16 states have reported some development activity. However, most activity is concentrated in fi ve states, namely, Gujarat, Andhra Pradesh, Maharashtra, Karnataka and Tamil Nadu. As a result, their share in total SEZ employment and investment between 2006 and 2009 increased from 73 percent to 77 percent and 57 to 85 percent, respectively. Other states are laggards. Third, while investment activity has been substantial across states, actual employment generation remains far below the proposed employment figures. Maharashtra, Tamil Nadu, Haryana and Orissa have generated one fourth of the proposed employment. Other states have shown rather poor performance in terms of the gap between proposed and actual achievements. Fourth, IT/ITES and electronics zones have together contributed 84 percent of employment and 60 percent of investment. Among the manufacturing zones, engineering and pharmaceutical zones have been successfully initiated. Other zones are slow to pick up. One caveat is that capturing employment generation potential in manufacturing zones will involve long gestation period. Finally, the SEZ-induced benefi ts are highly concentrated with top fi ve SEZs contributing more than 30% of employment, 42% of investment and 64% of exports (Table 3). It may be observed that the Jamnagar refi nery alone contributed one third of the total SEZ exports in 2009–10.

Strategising of SEZs: China vis-à-vis India 25 Table 3 Share of five top performing SEZs in employment, investment and exports: 2010 Share in Share in I Share in exports SEZ SEZ SEZ employment (%) (%) (%) Reliance Reliance Jamnagar SEEPZ SEZ 12.6 18.4 Jamnagar 32.7 Infrastructure Infrastructure Ltd. Limited Mundra Port & Surat Special MEPZ SEZ 5.7 11.6 12.1 SEZ Ltd. Economic Zone Infosys Infosys Noida SEZ 5.5 Technologies 4.5 Technologies SEZ 9.3 Limited(Mysore) Mangalore DLF Info city Vedanta Cochin Special Developers 3.4 4.1 5.7 Aluminum Ltd. Economic Zone (Chennai) Ltd. Kandla SEZ 3.1 Dahej SEZ 4.0 Nokia SEZ 4.3 total 30.3 42.6 64.1 Source: The Ministry of Commerce, Government of India.

5. A comparative analysis of India and China

India’s SEZ experience has been in sharp contrast to that of China. In the initial phases (for the fi rst 35 years), India essentially adopted the traditional approach towards SEZs and promoted them as trade enclaves with a focus on promoting trade fi rst by offering fi scal incentives a la orthodox approach and then by improving investment climate a la heterodox approach; China on the other hand viewed SEZs as a key element of its cluster-based industrialization strategy in the initial stage itself. The institutional structure of SEZs which provided considerable economic incentives and leeway to local authorities, large city-size, and openness of SEZs facilitated domestic linkages with SEZs in the initial stages itself. Subsequently, smaller zones were created in the proximity of the existing zones or near industrially developed locations/clusters to generate synergies between them and promote a critical size of economic activity. Further, the SEZ sector has been expanded both, horizontally (stretching from east costal region to inland middle and west region) and vertically (creation of zones within zones). The outlying localities have thus immediately integrated with the interiors due to economic dependencies of the latter on the former and triggered the process of circulation and cumulative causation. Agglomeration economies generated in the process facilitated further entrants, in particular foreign investors. There is a strong empirical evidence which suggests that existing SEZs have been a strong mechanism of attracting further FDI in China due to the possibility of backward and forward linkages (Amiti and Javorcik, 2008; Wang, 2009; Debaere et al., 2010). Wang (2009) shows that increasing investment in SEZs affects domestic investment also positively in the process. The strategy of locating HIDZs and ETDZs in the same region also paid off. It may be recalled that ETDZs have been set up to attract high tech foreign enterprises whereas HIDZs aim originally and specifi cally at fostering the development of high-tech indigenous fi rms. It is found that they are mutually reinforcing. Liu and Wu (2010) fi nd that an ETDZ with a HIDZ located in the same region (city) attracts signifi cantly more FDI after controlling the effects of other factors. To reinforce the dynamism, more recently, newer varieties of SEZs are being created within the existing zones. As a result of the dynamic forces generated by agglomeration economies, China succeeded in developing ‘growth poles’ around its large SEZs (Mathews, 2010). Two of the most powerful growth poles are: the Pearl River Delta (PRD) in the south with Shenzhen at the core and the Yangtze River

26 アジア研究 Vol. 57, No. 4, October 2011 Delta (YRD) in the east, with Shanghai as its principal cosmopolis. Mathews (2010) argues that as industrial concentration in Shenzhen and Shanghai grew, fi rms agglomerated around them. As a result, industrial towns and cities also emerged. He reports that there are more than 200 specialised towns in the PRD alone. Thus the success of Chinese SEZs is not due to their location in coastal areas as it is made out to be. In fact, in most countries, SEZs are located in coastal areas. China succeeded due to the spirit of experimentation with imaginative strategic approach adopted in the development of SEZs. Inspired by the success of China, India has also upgraded its SEZ programme to transform the country into a business, logistics and fi nancial hub of the region and create world class cities. India started expanding their zone programme in 2000 when a paradigm shift was introduced in the policy. In 2005, an SEZ Act was passed with high expectations. While it lacks strategic vision and roadmap for the future, it does signify a major change in the approach towards SEZs. The initial success indicates that the programme does have a potential of driving industrialization in the country. However, the government has never demonstrated strong commitment to the programme. In the wake of criticism, the government diluted the policy through policy reversals. Now new policy blocks are under consideration, which threaten to take away exemptions that make the SEZs attractive to investors. This has created uncertainty among investors and has already slowed down the process of establishing SEZs. There is a veritable queue of companies asking for extensions, resizing and denotifi cation of proposed projects. By July 2010, 12 SEZs were already denotifi ed; many other are waiting to be denotifi ed. The weak commitment, policy reversals and lack of vision in policy design and implementation may seriously jeopardize efforts to promote industrialisation through SEZs in future. There is thus a compelling need for the strategizing of SEZs such that they generate self- reinforcing processes and synergies with the domestic economy to the success of EPZ-led industrialization. However, an important ingredient to implementing a successful SEZ strategy is strong commitment that refl ects intense focus on growth, knowledge of the necessary and suffi cient conditions for growth, and belief in the strategy adopted for growth.

Notes 1) His work has had a great influence in policy circles with a substantial growth in the number of cluster-based economic development initiatives in many parts of the world (Martin and Sunley, 2003). 2) While Marshallian industrial districts were based on comparative advantages, Porter promoted the notion of competitive advantages. 3) The largest EPZ at Kandla was merely 1000 acres in size. 4) Punjab, Haryana, UP, Rajasthan, Gujarat, Maharashtra, Kerala, Andhra Pradesh and Tamil Nadu.

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(Aradhna Aggarwal, University of Delhi, India Email: [email protected])

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