Why Special Economic Zones Remain Important

Featured in Arabian Business

By Anshu Vats
This article first appeared in Arabian Business on September 29.           

Arabian Business also produced an analysis video based on the article, which can be viewed here.

Special Economic Zones (SEZs) derive their value from a combination of three key drivers: an encouraging regulatory environment that provides the necessary support the industry needs to take root in a new market; an operating environment that ensures both physical infrastructure (hard) and policies (soft) are in place to support businesses and their employees; and the more rudimentary element of incentives, financial and non-financial, that provide impetus for investment in a location that might other-wise be less appealing.

The UAE was a pioneer in harnessing the value of SEZs to attract foreign investment, driving growth in a more diverse range of economic activity with the launch of free zones in 1985. These free zones took advantage of mostly financial and non-financial incentives – which were unique in the region at the time.

However, as the initial growth and investor attraction plateaus out, the focus is increasingly sharpening on deeper value chain integration, where the lion’s share of GVA (gross value added) growth exists. Jebel Ali is a powerful example, with the development of Dubai South, integrating Jebel Ali Sea Port with the new Al Maktoum International Airport, and the provision of production/processing infrastructure to capture a far greater share of GVA than simple logistics alone offers.

With the development of such propositions, however, comes the need for a much deeper understanding of the comparative advantages needed for a sector (or even sub-sector) to ensure sustainable success of not just the one industry – but the economic outcomes for the host economy.

In line with much of the “new economy”, the traditional hard infrastructure components of SEZ propositions are reducing in relevance; the knowledge economy does not need an abundance of oil or iron ore on its doorstep, or industrialised trade routes through which to ship heavy goods.

As such, soft infrastructure is more important than ever: suitability of the regulatory regime; robust legal infrastructure to support IP rights and overcome business failures; the overall ease of doing business; the strength and consistency of institutions; and a compelling lifestyle proposition, coupled with intelligent incentives packages, are critical to a new SEZ proposition.

In our experience, a crucial aspect closely scrutinised by any potential investor in an SEZ is the governance model. Often, the primary catalysts for the creation of an SEZ are the institutional shortcomings in the host base economy, hence the governance of that zone must offer transparency, efficiency, consistency and security to succeed.

One of the most cited examples of a successful governance model is the Dubai International Financial Centre (DIFC). A material ingredient to its success can be attributed to its governance model (most famously the independent judicial system based on English law) to provide a compelling business environment for such economic activity.

Also, moving away from pure investor attraction or a real estate play, the new generation of SEZs should be measured on their contribution to the host nation’s economic objectives: increased (and diversified) GDP, better quality employment opportunities for citizen populations, and growth in export trade.

The new generation of special economic zones should be measured on their contribution to economic objectives

Removing barriers

Ultimately, SEZs should be a catalyst or transitional tool towards the integration of economic activity within the base economy itself. In many cases, SEZs act as a “safe” pilot or proof of concept for institutional reform that can then be adopted in the host economy, removing the need for such zones and absorbing the full economic value of their activities.

The GCC is well placed to reach the aspirational goal of removing the boundaries between host economy and SEZ – as the soft infrastructure is now increasingly being adopted by the government into the base economy – as witnessed by the new investor visas and ownership laws.

The goal for Gulf countries, then, would be to attract the most innovative investors from across the globe and create advanced economic activity locally through an innovative framework of incentives, regulation and governance.