When Governments Suspend Their Own Rules

Special economic zones can be anything from tools of crony capitalism to seeds of a freer world order.

The Political Economy of Special Economic Zones: Concentrating Economic Development, by Lotta Moberg, Routledge, 192 pages, $140

Routledge

All over the world, in carefully delimited areas, governments have carved out exceptions to their own rules. These special economic zones, better known as SEZs, come in many sizes and types, ranging from simple duty-free warehouses to jurisdictions the size and complexity of entire cities. Host governments typically roll back taxes, customs, and similar barriers to trade in their zones, but sometimes offer special labor, environmental, or financial regulations, too.

You probably live within a short drive of an SEZ: The United States has more than 400 of them, in the form of Foreign Trade Zones. Today most countries—about 75 percent—host SEZs of some sort. Worldwide, they number well over 4,000, and if you count micro-zones, some of them no bigger than parts of buildings, over 10,000.

Though the core idea runs back to ancient times (including the colonial proto-SEZs that gave rise to the United States), modern special economic zones started to emerge in 1948, when Operation Bootstrap made Puerto Rico a special trade and processing zone. A more popular model emerged in 1959, when the international airport in Shannon, Ireland, opened a special zone to accommodate transshipping and value-added processing. More recently, as with the zones that already fill China and that are planned in Saudi Arabia and Honduras, SEZs have grown to cover whole cities and areas of law.

The Political Economy of Special Economic Zones casts a coolly objective eye on this latest institutional mutation to issue from the roiling competition of global trade. Its author, Lotta Moberg, a recent graduate of George Mason University's economics doctoral program and now an analyst at the investment bank William Blair & Co., finds both opportunities and challenges in their rise.

As Moberg explains, politicians often have self-interested reasons to promote special economic zones. Sometimes they're merely seeking a new venue for graft. More honorably, they often hope the zones will attract investment, create jobs, and increase exports—and that voters will reward them for it.

Can SEZs work such wonders? Moberg voices doubt. Her book lays out the reasons, deeply informed by public choice reasoning, why SEZs too often distort economies rather than help them grow. Politicians lack the information and incentives required to plan and run the zones well. Many become burdens to their hosts, and they can distract policy makers from broader and more essential reforms.

Yet Moberg also reveals an underappreciated benefit of SEZs: Under proper conditions, they can help free an economy from pervasive rent-seeking and transition it to a more open system of market exchange. Her book concludes with insightful suggestions for how reformers can ensure zones fulfill this, their greatest potential. Among them: Make SEZs big, make them diversified, and let private parties rather than government agents choose the sites and run them.

Intellectuals have been theorizing about how to run governments for almost as long as governments have been running. But SEZs offer a unique opportunity for empirical study, an opportunity that Moberg seizes.

Special economic zones allow a single country to test different policies within its own borders. The popularity of America's Foreign Trade Zones, for instance, has scattered small, custom-free areas all across the country. SEZs also allow different countries to test the same policies across borders, as when Dubai imported the common law of England and Wales to its International Financial Centre. Social scientists could hardly ask for a better experimental framework for testing the real-world impact of varying rules.

Moberg's book draws on the author's field work, primarily in the Dominican Republic, and on other SEZ research, much of it conducted by the World Bank. From this rich collection of data, she produces a portrait sufficiently nuanced to show the zones at both their worst and their best.

At their worst, as exemplified in India, SEZs offer little more than an opportunity for politicians to reap the benefits of another layer of bureaucracy and to dole out special treatment to a few favored allies. For example, because Indian special economic zones qualify as public utilities, developers have used them to seize land from farmers unwilling to sell on the market. Dominican SEZs, which are fairly conventional duty-free export processing zones, present a more mixed case. They have attracted foreign investment to select areas but arguably provided no net benefit to the country as a whole, and they have evidently done little to encourage broader economic reforms.

For an example of SEZs at their best, Moberg looks to China. In contrast to the small and narrowly focused zones of India and the Dominican Republic, China's Special Administrative Regions encompass whole metropolitan areas; they offer not just a few tax breaks but a large set of unique rules and institutions. These Chinese jurisdictions didn't just liberalize the economy; they gave local officials incentives to press for further reform.

From this survey of the empirical evidence, the book draws an important lesson: SEZs that offer only fiscal incentives—a practice already under scrutiny by the World Trade Organization for unfairly subsidizing exports—can no longer compete with zones that involve more comprehensive reforms. Successful SEZs must, like China's, go broad and deep. "If policy makers and practitioners stick to such radical reforms as different judicial and political systems," she writes, "tomorrow's zone projects should be able to claim genuine success."

Decades ago, libertarian dreamers such as Robert Nozick and David Friedman imagined that someday, somehow, nation-states might cede a little bit of ground to private governing services. Today, Moberg's book can take that scenario for granted. Its survey of best practices discovers exactly what Nozick and Friedman would have predicted: Privately created and managed special jurisdictions tend to outperform public ones.

More than that, the robust political economy of Moberg's approach suggests that, when it comes to special jurisdictions, bigger and bolder work better than smaller and wimpier. The worst SEZs cover only single factories and offer little more than a narrow exemption from rules that everyone else has to follow. The best SEZs can lift entire regions—and eventually, whole countries—from the choking miasma of statism.

The Political Economy of Special Economic Zones performs a valuable service: It takes a serious look at the question of what you get when markets start taking over from governments. Better still, it advances the process of finding real-world answers.