A Natural Experiment
The Korean peninsula is known to be a natural experiment: North and South Korea have the same history, culture, language, and geography, but they have been having very divergent economic outcomes.
South Korea is an OECD country; it is very developed and has major industries, while North Korea often can barely afford to feed its people.
The reasons for South Korea’s success and North Korea’s failure can be broken down into man-made constraints on behavior. How easy is it to register a business? How easy is it to pay taxes?
The reader would normally think that the traditional way to change these rules is on a national level, with the government approving and passing a law. However, a special economic zone (SEZ) is a different way to change these rules: rather than adopt new reforms on an entire country, a specific area of that country will be subject to the test of this new system of rules to attract businesses and generate wealth, such as lower taxes or easier bureaucracy.
What is a Special Economic Zone?
A Special Economic Zone (SEZ) is a specific area in a country that is subject to different economic regulations than other regions within the same country.
SEZs are typically created to facilitate rapid economic growth, as they make the country benefit from foreign direct investments, tax incentives, export diversification and growth, and employment generation. SEZs are oftentimes used in developing countries, as they allow governments to implement reforms that are politically infeasible on a national level and to experiment with these new reforms before being rolled out nationwide if the effects are uncertain.
According to the specific reforms, there can be different types of SEZs. There are zones designated to become financial centers (Financial Zones), zones where goods may be imported and exported with untypical customs duties (Free Trade Zones – FTZs), or zones built for industrial and commercial exports (Export Processing Zone – EPZs).
However, a SEZ is not easy to develop, and many initiatives have failed. To succeed, SEZs must have strong economic ties to the broader country, an efficient regulatory framework that makes them competitive places to do business, and efficient private sector participation. The latter must be given strong incentives to pick the right location, target the right industries, and effectively administer the zone.
SEZs in China: “Crossing the river by touching the stones”
The first modern Special Economic Zones appeared in the late 1950s in industrialized countries, with the very first one created in Shannon Airport, Ireland. From the 1970s onward, zones providing labor-intensive manufacturing have been established, especially in Latin America and East Asia. However, SEZs showed their true potential when China created four of them in the early 1980s. Among them was Shenzhen, which passed from a rural city of 30,000 people to the 18 million people manufacturing capital of the world in 2018.
While SEZs have been used by many countries, The Red Dragon has been the most successful in using them, especially in more technology- and capital-intensive formal sectors that enjoy greater government support, more foreign direct investment (FDI), and stronger links to the global market.
China’s first SEZs were created in the Southeastern coastal region to act as liberal economic environments that promote innovation and to test the efficacy of market-oriented economic reforms in a controlled environment; in Deng Xiaoping’s words, “crossing the river by touching the stones.” Therefore, these four SEZs didn’t only have the usual objectives of a SEZ, but they had one important mission as well: test the new policies and institutions for a market-oriented economy, a substantial change from the former centrally planned economy.
China says thank you to SEZs
The SEZs had an immediate impact: in 1981, they accounted for 59.8% of China’s FDI, with Shenzhen accounting for half of it, and by 1985, Shenzhen’s and Zhuhai’s GDPs respectively grew at an annual rate of 58% and 32% against a national average of 10%.
By 1992, foreign trade and investments in China had been extended to the entire coastal region and all capital cities in the interior, and SEZs began to spring up throughout the country as much as they were no longer “special”.
China’s first four SEZs, Shenzhen, Zhuhai, Shantou, and Xiamen, are crucial to understanding the insane development and growth the country has experienced in the last thirty years and its consequent position on a macro and geopolitical basis.
From 1975 to 2018, the number of countries with SEZs has grown from 29 to 147, with the total number of SEZs in the world growing at an annual rate of 157% in the same period. Yet, no country has enjoyed their benefits as China did.
Most of all, China’s SEZs successfully tested the market economy and new institutions, establishing role models for the rest of the country to be followed. They had a huge contribution to national GDP, employment, equality, poverty, exports, and attraction of new technologies and talents, and they undoubtedly made the country able to liberalize the formerly traditional state and experience the consequent flourishing growth.
Now, the question remains how the Party – which is becoming increasingly corrupted, autocratic, and culturally closed – is going to transform this insane economic growth into geopolitical influence on Asia and the world.