What’s next for the special economic zones?

Read the article in the Cayman Financial Review Magazine 

Viewed from a distance, Earth is teeming with trouble. Highly indebted nations are sliding towards bankruptcy. Over-leveraged financial institutions cling to central bank lifelines. Trust in government is heading toward an abyss, as people worldwide respond with disgust to increasingly visible corruption and favour-giving. 

Yet a closer view stirs hope. While often overlooked, areas of concentrated economic policy reform are emerging as the most vibrant areas in the global economy. By contrast with surrounding areas, they offer trustworthy business climates with minimal tax, tariff and/or regulatory hurdles for investors and entrepreneurs. New cities are rising where swamps, deserts and pasture land once stood.

Surprising trends are at work in these areas, known variously as special economic zones, export processing zones, free ports and enterprise zones. Opportunities are taking form that may influence the lives of hundreds of millions, if not billions, of people in the decade ahead.
1. Free zones are soaring in number

Walter Diamond, editor of Tax-Free Trade Zones of the World, began tracking areas of economic freedom in the 1976. His first edition profiled fewer than 300. Today, the number of free zones worldwide is ten times greater. And the forces driving creation of free zones are intensifying.

One force behind the rapid growth is “pork-barreling”. Localities have been pressing national governments for free zone designations, after seeing them work for an increasing number of other communities. Surprisingly, politicians often agree to radical reforms that reduce barriers to investment and jobs. Each free zone area – being limited in size – poses little threat at a national level to politically-favoured interests benefiting from the status quo.

Other forces are driving the spread of free areas: 

  • Costs are falling for free zone startups. Long ago, free zones were entrepôts based at seaports – free ports requiring extensive infrastructure investments. Industrial park-style free zones in more recent times have sprung up near airports, helping propel the export success of the Asian “tigers”. Today, however, free zones can be started at a tiny fraction of former costs. Affordable telecommunications make it possible to set up free zones in a single building for global information services exports, ranging from customer service/technical support call centres to animation, research and software development.
  • People are seeking local solutions. Free zones are springing up as confidence ebbs in highly indebted and increasingly corrupt governments. Decades of high public spending and borrowing have shaken trust in the future fiscal health of developed countries. Regions are pressing for self-governance and freedom to experiment with new rules. After negotiating an escape from high taxes and predatory regulations, communities with free zone designations often see land values rise five-fold within a short period. In the case of Shenzhen, land values have soared more than 50 times in three decades after the former fishing village won SEZ status. Private, risk-taking developers accordingly can realise exceptional returns by building in areas that offer world-class conditions for new ventures to thrive.

Creditors are hedging against default risks. Prospects of sovereign debt default and/or sharp currency devaluations also are whetting investor interest in free zone development. As credit ratings of national governments decline, their sovereign debt can be purchased at a discount – sometimes, for pennies on the dollar. Investors and developers who purchase such IOUs, and then swap them for long-term leaseholds on state-owned lands, can enjoy exceptional gains after the sites become free zones.

Similar opportunities also arise when a national currency appears at risk of a sudden devaluation. In such cases, local currency holders can obtain land leases and building materials prior to devaluation – and then obtain free zone concession. Following a devaluation, the newly-created free zone can attract tenants who pay in hard currency given the zone’s exemption from foreign exchange controls.

2. Zones are growing freer

The quality of business environments offered to investors and job-creators is rising, as the number of economically liberalised areas grows.

Tax, tariff, regulatory conditions are generally improving. Free zone success in global markets hinges on their staying competitive. At early stages, pioneering free zone countries such as Taiwan offered five-year tax holidays to investors in export processing zones. Other countries extended the tax-free period to 10 or more years. In the case of Uruguay, taxes on export industries in free zones are lifted in perpetuity. Similarly, global competition has prompted zones to speed up customs clearance procedures and to introduce new fast-track, “one-stop” systems for registering companies and issuing licenses.

Work permits/visa policies are liberalising.

As developed countries have moved to restrict immigration, many free zones have opened doors to visitors and workers from other countries. Dubai’s work permit/visa system has allowed millions of incoming foreigners to find work in recent decades, provided they are sponsored by an employer and prove they have a confirmed job. This policy has yielded billions in dollars from work permit and visa fees. Similarly, over the past decade, the free zones of Singapore, the Dominican Republic, Uruguay and other countries have benefited from an easing of immigration barriers, especially to attract foreign-born engineers and other highly skilled workers.

Public sector monopolies are ending. Uruguay’s free zone act affirms that “no commercial governmental monopolies shall apply in the free zone”. Companies that are heavy telecommunications users – call centres, financial back office operations and software development firms – have poured into the country’s privately developed Zonamerica in response. Similar exemptions have helped create thousands of free zone-based information processing jobs in the Dominican Republic and other countries in the Caribbean Basin.

Rewards for honest governance are growing. In Singapore, all public employees are eligible for bonuses based on the overall growth rate of the private sector. Since 1986, this “flexi-wage” policy has created a culture in the civil service fiercely opposed to corruption, and favourable to eGovernment solutions that make it easier to invest.

Free zones in the European Union have run counter to global trends. Pressure from Brussels over the past 15 years to “harmonise” levels of taxation has led Ireland and other countries to withdraw incentives once offered in free zones. Yet the severity of the Eurozone crisis has led to new interest in zones. Over the past year, Germany has announced a six point plan to promote special economic zones in Eastern Europe and Greece as a way to revive struggling areas.

3. Zones are becoming centres of innovation

As conditions in free zones grow more attractive, global investments and talents are moving a number of zones into centres of technological innovation.

Singapore has earned a top ranking as a centre for R&D. INSEAD’s global innovation index last year placed Singapore third for “innovation performance”. The city-state’s rigorous enforcement of intellectual property has prompted a number of global firms to move research intensive work into the freeport. Liberalised visa policies are also attracting world-class engineers, scientists and designers.

In China, the first special economic zone in Shenzhen is home base to Huawei, ZTE and Tencent, as well as other leading edge telecommunications and internet technology firms. China has also launched dozens of technology-oriented zones, including the 68sq.km Suzhou technology park in partnership with Singapore.

Dubai is also rapidly moving into advanced markets. Following the success of its industrial and transshipment-oriented Jebel Ali Free Zone, the Dubai Technology and Media Free Zone Authority launched with TECOM a series of specialized free zones. These include as Dubai Media Internet City, Dubai Media City, Dubai Knowledge Village, Dubai International Academic City, International Media Production Zone, Dubai Outsourcing Zone, Dubai Studio City, the Dubai Biotechnology and Research Park, and the Energy and Environment Park.

Songdo free zone in South Korea is home to a $35 billion new privately developed city. Gale International, a US developer, Korea’s leading steel company, and Cisco have joined to make it the world’s leading “smart community”. A Global University Campus is being constructed for 10 international universities. GE will open a R&D centre for health technology R&D. Other partners are developing green technology innovations as well as an “aerotropolis”, a state-of-the-art international airport.

4. Free zones are finding better ways to meet social needs

Even as overstretched welfare states face bankruptcy, leading free zones are using land value-based funding to support social initiatives. Hong Kong and Singapore’s policy of offering long-term leaseholds of land has generated a windfall in recent decades. Auctions and tenders of publicly owned land have netted more than $70 billion in this period for Hong Kong, where all land is publicly owned but leased out long-term to the private sector.

Funding social services through land value capture creates an interesting dynamic. Lease revenues are maximized by a policy of delivering world-class business climates. According to annual ratings by the Fraser and Cato Institutes, the Heritage Foundation and Transparency International – Hong Kong and Singapore consistently are in top five freest and least corrupt economies of the world. 

Their free zone polices enable them generously fund social services while keeping tax burdens at low levels for investors and employers.

Adopting a similar approach can help tax-burdened nations and communities around the world avoid fiscal cliffs. Rather raise taxes to deal with their rising entitlement claims and debt repayment burdens – moves that will only continue to shift global capital and talent into free zones – countries can follow Hong Kong and Singapore’s lead. They can transfer public lands into community land trusts, and then awaken their value by introducing full-strength free market reforms. Rising asset values in large new “endowment zones” created to fund social services, as free zone specialist Zachary Caceres has noted, can provide a safety net for hundreds of millions who otherwise will face hard landings.

5. Free zones are filling geopolitical voids

As fiscal woes mount and the downsides of military interventions become clear to great powers, free zones are emerging as a self-funding new way to bring transparency and economic opportunity to troubled areas. A “soft power” competition to spread world-class free zones seems to be emerging.

In Africa and Central America, China is now approaching governments with proposals to partner in formation Special Economic Zones. Germany has announced a plan to help rekindle growth in Eastern Europe and Greece through a new network of free zones. In the United States, conservative politicians and media such as the Weekly Standard have called for creation of “free cities” in emerging nations, backed by bilateral treaties.

City/states and private developers also are going global to form new free zones. Dubai has formed partnerships with Senegal and Djibouti. Singapore has announced an interest in a network of up to a dozen “little Singapores”. As a result of its success with a technology park and logistics/manufacturing zone Uruguay, Zonamerica has embarked upon an expansion campaign that includes a recently-signed joint venture in Colombia. Promoters of “Startup Cities” in Central America are now exploring locations for free zones that include local residents and education initiatives as beneficiaries of land value gains.

Free zones may have a part as well in opening the door to humanity’s next great frontiers. Peter Thiel, a billionaire from his early investments in Facebook and Paypal, is funding initiatives by the Seasteading Institute to create new floating communities with independent political status. One focus will be to fast track R&D for breakthroughs in pharmaceuticals and other heavily-regulated markets.

Established and start-up space ventures can also benefit from free zone environments. Several are eyeing equatorial launch sites, so as to more efficiently loft commercial vehicles into orbit. Establishing spaceports as free zones – “Earthports” – could help lower tax and regulatory barriers on private investors and entrepreneurs. The possibility has been endorsed by Arthur C. Clarke and Buckminister Fuller, among other global visionaries, as a promising way to encourage peaceful commercial and scientific use of outer space.
In less than four decades, as economist Paul Romer has noted, special economic zones have sparked reforms responsible for China’s rise. Applying lessons learned in free zones – laboratories for policy innovation – has lifted hundreds of millions from poverty to prosperity.

As other countries grapple to change dysfunctional policies and practices, free zones offer a way forward. They provide a rewarding and feasible way to experiment with needed reforms to increase transparency and accountability in governance, which are essential to reversing the decline of trust in public institutions.
Japan, having exhausted other options, has just announced its intent to create “strategic economic zones” as testing grounds for deep reforms.

Around the world, publics are weary of top-down solutions advanced by politicians. Special economic zones offer an alternative path, awakening assets by creating level field environments for ventures of all kinds to thrive. In the Internet era, their successes are becoming more widely seen, prompting more communities to press for their activation. A Hanseatic League-style network of free zones and free cities may arise as such projects emerge, and blaze new trails for the planet toward liberty and prosperity.


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Mark Frazier

Mark Frazier is president of Openworld Inc., a nonprofit group assisting free economic zones and land grant endowments to build assets for social ventures. A specialist in zones for information industries, he has worked in more than 50 countries on free zone incentives, market development, and financing strategies. He is a graduate of Harvard University, a past publisher and managing editor of Reason magazine, and a former Visiting Fellow of the Lehrman Institute.

Mark Frazier
Openworld, Inc.
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Washington, DC, 20006

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