The establishment of SEZs mushroomed from an estimated 176 zones in 1986 to more than 4,500 in 2015, with the bulk based in developing countries 

Targeted industrial and development policies have re-emerged as the go-to apparatus for attracting investment to strengthen domestic productive capacity and international trade competitiveness. Meanwhile, the global launch of the UN’s Sustainable Development Goals (SDGs) has driven home the need for governments worldwide to promote and facilitate not just more investment, but the right kind of investment.

A proven policy option for developing-country governments is the establishment of special economic zones (SEZs). These zones can promote investments capable of delivering the desired capacity-building and technology diffusion outcomes and, in addition, offer significant latent potential to attract and leverage sustainable development-oriented investment.

SEZs – sometimes called export-processing zones, industrial development zones, free trade zones or a range of other epithets – have seen a spectacular rise in popularity over the past few decades. Situated in geographically demarcated and administered hubs, with a wide set of advantages designed to lure investment and stimulate trading opportunities, SEZs became de rigueur in the 1990s and early 2000s as a vehicle for host countries to develop manufacturing capabilities and competitive industrial labour forces. Apart from direct fiscal incentives, a range of other benefits – such as dedicated services and infrastructure or administrative management assistance – may be conferred to enhance the efficiency and cost-effectiveness of operations in the zone.

From a policy perspective, the concentrated nature of an SEZ provides policymakers with a demarcated, purpose-built industrial site of manageable scale to negotiate the complex demands of developing industrial activity-oriented infrastructure and the affiliated regulatory environment. An SEZ, therefore, provides quasi-laboratory conditions where policies and industrial development approaches can be tested, with a view to replicating them on a larger scale if successful. They also provide fertile ground to hone business linkages with regional or global value chains, thereby stimulating trade participation.

As a result of these benefits, the establishment of SEZs mushroomed from an estimated 176 zones in 1986 to more than 4,500 in 2015, with the bulk based in developing countries. Nonetheless, developed countries, including Ireland, New Zealand and the US, also boast them.

Triple challenge

The economic success of SEZs is not necessarily guaranteed, however. In recent years, the operating environment has toughened, and today three challenges in particular confront the zones.

The first is the difficult global economic environment: since the global financial crisis of 2008, demand for trade has been chronically weak, while trade growth itself has been slow. With two thirds of global trade depending on the operations of multinational enterprises, foreign direct investment (FDI) in economic zones has been choked as a result. Indeed, the road to global FDI recovery has been bumpy, and the level of investment flows remains below the peak level seen in 2007.

The sheer number of economic zones also means there is fierce competition between them – within regions and globally – as countries liberalise investment rules and up the ante with investment promotion measures, competing to attract investors to their zones.

The second challenge is the erosion of location-based advantages. For economic zones, the slow growth in global trade and investment is compounded by the erosion of location-based advantages that traditionally profited SEZs. That is, the locational factors that previously attracted capital to investment opportunities have been altered by technological advances. Cheap labour and abundant land are no longer sufficient to ensure investors will sign up, as enhanced digitalisation and the proliferation of automation have become important drivers of competitiveness, and thus determinants of investment.

The third challenge relates precisely to the sustainable development imperative, which has moved to a high position on the global agenda since the announcement of the SDGs in 2015. The SDGs will determine the development objectives of the international community over the next 15 years. Multinational enterprises and SEZs alike are under considerable pressure to curb their impact on communities and the environment, while also pursuing business activity that will help advance the SDGs. As such, a marked shift in corporate behaviour and business models is already under way. This change has largely been directed from within corporate ranks, as reputational risk factors prompt the private sector to adhere to ever-stricter environmental, social and corporate governance (ESG) standards.

The power of larger firms is driving this change not only within industries, but across entire value chains, with smaller competitors and suppliers being actively encouraged to change their behaviours. This has put SEZs – which are an integral part of global and regional value chains – at the centre of international pressure to comply with elevated ESG standards and explore sustainable development business models.

Five ways to sustainability 

The latter challenge, in fact, also presents the first opportunity for SEZs to reinvigorate their competitiveness through a shift in perspective and presentation. A 2013 United Nations Conference on Trade and Development (UNCTAD) survey of SEZs indicated that the zones provide limited sustainability-related services – if any. However, a handful of pioneering SEZs explicitly offer services across multiple areas of sustainability, including the areas of labour practice, environmental sustainability, health and safety, and good governance (or actively combatting corruption). Such commitments have stood them in good stead.

Maintaining the broad notion of these hubs as centres of excellence, SEZs could reconfigure themselves into sustainable development zones, establishing themselves as models for incubating pro-SDG business activities. The conversion of SEZs into SDG-oriented hubs could also aid cost-effectiveness and provide a solid platform for promoting and facilitating investment in specific and interrelated SDGs sectors. This could, in turn, inject impetus into a host country’s broader efforts to advance sustainable development imperatives, potentially delivering SDG-hub prototypes that could be replicated elsewhere.

At the same time, SDG-focused conversion could reorient economic zones that have lost focus by providing them with a new strategic purpose and, potentially, a new lease of life.

The second opportunity for SEZs to become more competitive is to adopt a partnership approach, which could also revitalise stagnant, uncompetitive economic zones. Investment promotion agencies (IPAs) and outward investment promotion agencies (OIAs) are specialised in catalysing FDI – often in challenging environments and difficult circumstances. These institutions play an important role in identifying and seeking out opportunity, and providing financing and services for investment projects, especially in developing countries. Forming strategic alliances with IPAs in their own countries and with OIAs (including development banks) in FDI-source countries could benefit SEZs, particularly if such alliances are organised around common objectives – for instance, to promote and facilitate private investment in sustainable development sectors or issue areas.

Enhanced competitiveness 

The potential goals and benefits from such partnerships could foreseeably include information sharing, technical cooperation and the marketing of SDG investment opportunities, among others. OIAs in particular possess the requisite competencies in order to: secure financial resources for SDG investment projects; help reach out to their private sector client base in home countries; assist in mitigating project risks; complement expertise in project preparation, assessment and approval; and partner in project monitoring and impact assessment. Inclusive, multi-stakeholder platforms, such as UNCTAD’s World Investment Forum and its technical assistance packages, can provide opportunities to facilitate such partnerships.

The third opportunity is the adoption and strategic integration of digital technology, which is key to the survival of SEZs. The incorporation of digital technologies in global supply chains across most industries has had a profound effect on international production. Digitalisation presents challenges but also opportunities within these international production networks. SEZs’ very lifeblood is the provision of value chain linkage opportunities to firms located within the zone. It is therefore essential that they advance digital adoption and connectivity if they are to remain as competitive and relevant players within these networks.

Fourth, SEZs could strengthen their position if they hone in on creating linkages with domestic firms – in particular, by attracting lead firms that can link up directly with producers and anchor down activity in the zone. These firms can provide technical support, training, finance and even inputs. They can also help set benchmarks to assist supply firms, something that is often tricky and complex.

Lastly, numerous new forms of private finance have sprung up in recent years, which have broadened the scope and diversity of investor bases that can be sought out. SEZs could stand to benefit if they explore these innovative financing options. They include venture capital funds, fintech firms, impact investment funds and crowdfunded ventures. Although still in their infancy in many developing countries, such investors nevertheless provide viable funding streams to smaller firms (that often set up shop in SEZs) that might otherwise be overlooked by risk-averse finance institutions, such as banks. In India, for instance, venture capital has helped boost start-ups in sectors with high growth potential, with international and domestic operators providing funding to promote growth in sectors such as IT and biotechnology.

For SEZs to survive in the challenging current environment, SEZ policy must innovate, moving away from the provision of low-cost export hubs with weak standards, towards the establishment of global centres of excellence in sustainable development. Through novel competitive advantages, secured by providing not only high-quality infrastructure but also robust accompanying environmental and social standards, SEZs can be restructured to increase their effectiveness in attracting investment from multinational enterprises seeking increased sustainability integration in their value chains.