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Economic and Political Weekly November 4, 2006 4533
ARADHNA AGGARWAL
Export Processing Zones (EPZs) are
an international phenomenon in-
fluencing increasing share of
trade flows and employing a growing
number of workers. In 1986, there were
176 zones across 47 countries; by 2003,
the number had increased to over 3,000
across 116 countries.
Over the past few years, the policy of
promoting zones has found favour with
the government of India as well. In 2000,
the government replaced the old EPZ
regime by a new scheme of “Special
Economic Zones” (SEZs) with several
lucrative incentives/benefits that were not
available in the earlier scheme. In 2005,
it enacted the SEZ Act and the SEZ
Rules were notified in February 2006.
The policy is expected to give a big push
to exports, employment and investment in
SEZs. The ministry of commerce claims
that these zones are expected to attract
investment of about Rs 1,00,000 crore
including FDI of Rs 25,000 crore and
create additional 5,00,000 direct jobs, by
December 2007.
These claims notwithstanding, the
policy has come under heavy criticism.
Dissenters contend that the policy
would be misused for real estate deve-
lopment rather than for generating
exports. Concerns have also been ex-
pressed on the displacement of farmers
by land acquisition, loss of fertile agricul-
tural land, a huge revenue loss to the
exchequer and adverse consequences of
uneven growth.
This article revisits the debate. It
describes the economic rationale for
SEZs; examines India’s experience with
EPZs/SEZs; discusses the context in
which SEZ policy is being promoted in
the country; reviews the arguments for
and against SEZs; analyses what went
wrong, from the perspective of the
promoters of the scheme; and finally,
draws lessons.
The promotion of SEZs is an attempt
to deal with infrastructural deficiencies,
procedural complexities, bureaucratic
hassles and barriers raised by monetary,
trade, fiscal, taxation, tariff and labour
policies. These structural bottlenecks
affect the investment climate adversely
by increasing production and transaction
costs. Since country-wide development of
infrastructure is expensive and implemen-
tation of structural reforms would require
time, due to given socio-economic and
political institutions, the establishment
of industrial enclaves (SEZs/EPZs) is
seen as an important strategic tool for
expediting the process of industrialisation
in these countries. The zones offer numer-
ous benefits such as, (i) tax incentives,
(ii) provision of standard factories/plots
at low rents with extended lease period,
(iii) provision of infrastructure and utilities,
(iv) single window clearance, (v) simplified
procedures, and (vi) exemptions from
various restrictions that characterise the
investment climate in the domestic
economy.
These benefits foster a conducive
business environment to attract local
and foreign investment, which would
not otherwise have been forthcoming.
The competitive advantages of zones
may also be explained within the frame-
work of the “cluster approach”. Zones
are industrial clusters where external
economies of scale and other advantages
help the operating firms in reducing
costs, developing competitive produc-
tion systems and attracting investment,
in particular, FDI. As a result of these
benefits, many developing countries
have been promoting zones with the
expectation that they will provide the
engine of growth to propel industrialisation.
There is, however, no conclusive
evidence regarding the role of the zones
in the development process of a country.
The literature review indicates that
while some countries have been able to
capture the dynamic and static gains
from zone operations, many others have
not [Aggarwal 2006a]. In that context,
it is important to analyse the Indian
experience.
Indian Experience
A micro level analysis of the zones’
contribution to industrialisation efforts in
India reveals that EPZs have had a catalytic
effect in promoting new production
sectors, exporting new products and in
building up the country’s image in certain
products in international markets
[Aggarwal 2006b]. The foundation of the
modern jewellery industry in India, for
instance, was laid in SEEPZ in Mumbai
in 1987-88. It was there that the “wax
setting technique” was introduced in
jewellery production, which made mass
scale production possible and dramati-
cally transformed the labour-intensive
jewellery industry from its cottage in-
dustry status into a highly mechanised
modern industry. SEZs accounted for
over 55 per cent of total Indian jewellery
exports in 2002-03. Zones have also been
instrumental in creating the base for
the growth of the electronics industry
through technology transfers, spillovers
and demonstration effects. Until the early
1980s, electronic hardware exports were
primarily originating from EPZs. Even
during 2000-02, the share of SEZs in
total hardware exports was as much as
26 per cent. The Indian software saga
also really began in SEEPZ, Mumbai
[Heeks 1996]. The first major breakthrough
in India’s software exports came in 1977
when the Tatas established a unit in
SEEPZ in partnership with Burroughs,
an American company, to export software
and peripherals. A further breakthrough
in the progress of the industry occurred
when, in 1985, Citibank established a 100
per cent foreign-owned, export-oriented,
offshore software company in SEEPZ.
This company drew attention to the
possibilities available for offshore soft-
ware development in India. Soon after,
Texas Instruments and Hewlett-Packard
established subsidiaries in Bangalore, in
1986 and 1989, respectively and the rest
is history.
The success stories notwithstanding,
the economic contribution of SEZs
remained minuscule at the national level.
Though India was the first Asian country
to take the free zone initiative and set up
the first zone in Kandla as early as in 1965,
Special Economic Zones:
Revisiting the Policy Debate
A discussion of the pros and cons of the controversial
SEZ policy.
Economic and Political Weekly November 4, 20064534
the share of SEZs in exports was a mere
5 per cent in 2004-05. Furthermore, they
accounted for only 1 per cent of factory
sector employment and 0.32 per cent of
factory investment in the same year
[Aggarwal 2006b]. Their contribution
to regional economies has also been lim-
ited. Although they have had a positive
impact on regional employment and
human development by creating economic
opportunities, especially for those without
high levels of schooling, their potential
in contributing to human development
has not been fully exploited due to their
failure in attracting investment and pro-
moting economic activities in the region
[Aggarwal 2006c].
SEZ Regime: Indian Context
The 1991 reforms did not result in a
sustainable growth in manufacturing,
there was a significant slowdown in the
second-half of the 1990s. Bureaucratic red
tape, administrative procedures, rigid
labour laws and poor infrastructure are
believed to have affected the investment
climate adversely in the manufacturing
sector [Acharya 2006]. To address these
issues, the government reverted to EPZs
with the expectation that if they could
effectively be separated from the rest of
the economy then they could provide
the “engine of growth” to propel the
manufacturing sector. It was argued that
the existing zones could not succeed in
attracting investment because of the lack
of government commitment to the
programme, piecemeal reforms, policy
reversals, poor site selection, failure to
provide word class infrastructure, weak
incentives and poor regulation of the zones.
In a major initiative to boost export-led
growth and motivated by the success of
Chinese SEZs, the government replaced
the EPZ scheme with the “SEZ scheme”
in 2000. The main difference between an
SEZ and EPZ is that the former is an
integrated township with fully developed
infrastructure whereas an EPZ is just an
industrial enclave. Under the new scheme,
all existing zones were converted into
SEZs and three greenfield SEZs became
operational by 2004. However, the impact
of SEZs remained far removed from
expectations. In order to provide a signifi-
cant thrust to the policy, the government
enacted the SEZ Act 2005. The act became
operative in February 2006 after the
SEZ rules were framed and notified. In
addition, state governments also enacted
their own SEZ laws, primarily to cover
state subjects. The salient features of the
SEZ Act are as follows.
Governance: An important feature of the
Act is that it provides a comprehensive
SEZ policy framework to satisfy the re-
quirements of all principal stakeholders in
an SEZ – the developer and operator, oc-
cupant enterprise, out zone supplier and
residents. Earlier, the policy relating to the
EPZs/SEZs was contained in the Foreign
Trade Policy while incentives and other
facilities offered to the SEZ developer and
units were implemented through various
notifications and circulars issued by the
concerned ministries/departments. This
system did not give confidence to investors
to commit substantial funds for develop-
ment of infrastructure and for setting
up units.
Another major feature of the Act is
that it claims to provide expeditious and
single window clearance mechanisms.
The responsibility for promoting and
ensuring orderly development of SEZs is
assigned to the board of approval. It is to
be constituted by the central government.
While the central government may suo
motu set up a zone, proposals of the state
governments and private developers are to
be screened and approved by the board.
At the zone level, approval committees are
constituted to approve/reject/modify
proposals for setting up SEZ units. In
addition, the Development Commissioner
(DC) and his/her office is responsible for
exercising administrative control over a
zone. The labour commissioner’s powers
are also delegated to the DC. Finally, clause
23 requires that designated courts will be
set up by the state governments to try all
suits of a civil nature and notified offences
committed in the SEZs. Affected parties
may appeal to high courts against the orders
of the designated courts.
Incentives: The Act offers a highly at-
tractive fiscal incentive package, which
ensures (i) exemption from custom duties,
central excise duties, service tax, central
sales taxes and securities transaction tax
to both the developers and the units; (ii) tax
holidays for 15 years (currently the units
enjoy a seven year tax holiday), i e, 100
per cent tax exemption for 5 years, 50 per
cent for the next five years, and 50 per cent
of the ploughed back export profits for the
next five years1; and (iii) 100 per cent
income tax exemption for 10 years in a
block period of 15 years for SEZ developers.
Institute for Studies in Industrial Development (ISID)
New Delhi
Faculty Positions
ISID proposes to recruit Faculty seeking a career in research at the Institute, at different
levels of Professor, Associate Professor and Assistant Professor/Research
Associate. These carry UGC pay scales.
Candidates for the posts of Professor and Associate Professor should have a doctoral
degree, good academic record and research experience of ten and five years, respectively.
Minimum qualification for Assistant Professor/Research Associate is a Ph.D. Candidates
should have aptitude for undertaking empirical research in at least one of the following
areas: foreign investments, international trade, technology, IPRs, capital markets, public
enterprises, SMEs, industrial location, entrepreneurship, corporate affairs, competition
law, regulations and employment.
Candidates may kindly send their resume stating qualifications, experience and publications
along with names of two referees. Copies of the publications need not be sent. Last
date for receiving the responses at the institute is November 20, 2006.
All communications to:
The Director, Institute for Studies in Industrial Development, 4 Institutional Area,
Vasant Kunj, P.B. No. 7513, New Delhi – 110 070. Phone: 011-26891111.
email: director@vidur.delhi.nic.in director@isid.org.in.
Economic and Political Weekly November 4, 2006 4535
Table 1: Current Status of Upcoming SEZs
SEZ Status Investment Employment (No)
Nokia, Tamil Nadu: Commenced commercial US$ 100 Million Direct : 2800
production Indirect : 10000
Quark City, Chandigarh: Inaugurated $ 0.5 billion FDI* 35000* by May 2007
Flextronix in Tamil Nadu Commences operation $100 million 3000* (2500 under
in November 2006 training)
Motorola and Foxconn, Units being set up $200 million* 5000* by December 2007
Tamil Nadu
Apache SEZ (Adidas Construction started $50 million* 25,000*
Group), Andhra Pradesh
Divvy’s Labs, Commenced operations NA 8000* by April 2007
Andhra Pradesh
Rajiv Gandhi Technology Construction started NA 5000* by June 2007
Park, Chandigarh (500 under training)
Brandix Apparel SEZ, Construction started $100 million* 26000* by March 2007
Andhra Pradesh
*Expected.
Infrastructure: Provisions have been
made for (i) the establishment of free
trade and warehousing zones to create
world class trade-related infrastructure
to facilitate import and export of goods
aimed at making India a global trading
hub; (ii) the setting up of offshore bank-
ing units and units in an international
financial service centre in SEZs; and
(iii) the public private participation in
infrastructure development; and (iv) the
setting up of a “SEZ authority” in each
central government SEZ for developing
new infrastructure and strengthening the
existing one.
There has been a tremendous rush to
set up SEZs since the Act came into effect
in February 2006. The total number of
approvals and in-principle approvals across
21 states as on October 27, 2006, was 212
and 152, respectively. As on date, 34 SEZs
out of these approvals have been notified.
Table 1 shows the current status of the
upcoming SEZs.
The Debate
The SEZ policy has become one of
the most hotly debated issues in recent
years. Huge protests are being organised
by those who stand to lose their land.
There has been a scathing campaign
against SEZs by politicians, scholars,
media and civil society. Of much more
concern however is the fact that there
are differences within the government
too. The Congress president Sonia
Gandhi has also expressed her reserva-
tions over the impact of SEZ policy on
displaced farmers and the Reserve Bank
of India has asked the banks to treat
SEZ lending as real estate business
and not infrastructure. The advocates
of the policy led by the ministry of
commerce have however strongly de-
fended the policy. Table 2 summarises
some of the major concerns and counter
arguments.
Though the ministry of commerce has
attempted to dispel the criticism of the SEZ
policy, the fact remains that the SEZ Act
was framed without giving adequate
thought to most of the ancilliary issues.
No exercise was undertaken to ensure
that legal institutions are in place for
massive land acquisition. No long-term
strategy was drawn to counter the socio-
economic consequences of the scheme.
Even amid heavy criticism of the policy,
no serious research has been conducted
Table 2: Arguments For and Against SEZs
Issue Argument against SEZs Counter Arguments for SEZs
Relocation – Companies will simply relocate to SEZs – Special provisions have been made
to take advantage of the tax concessions in the act under which tax exemptions
being offered and little net activity will are applicable only if the unit is not
be generated. formed by splitting up, or the
reconstruction, of a business already
in existence and it is not formed by
the transfer to a new business of
machinery or plant previously used
for any purpose.
– Relocation of units to SEZs would
involve cost and loss of efficiency.
– There is little incentive to relocate
due to the continuation of various
export promotion schemes such as
the duty drawback scheme for
outside units and other business
practices prevalent outside the zones.
Revenue loss – The policy would cause a revenue loss – Revenue loss is notional as without
of Rs 9,39,000 million over the next the SEZ Act, there would not be much
four years. If an annual average of this investment in the zones.
four-year figure is drawn, it comes out – SEZs would bring a net revenue gain
to be Rs 23,475 million, which is about of Rs 4,40,000 million on account of
6.7 per cent of the central government’s additional investment activities.
total revenue receipts during 2005-06.
Land acquisition – The act will lead to a large-scale land – The land requirement of all SEZs
acquisition by developers, displacement (including those under consideration)
of farmers, meagre compensation and is 1,00,000 hectare, which is less
no alternative livelihood for them. than 0.1 per cent of total cultivable
land in India.
– The total land area in 212 formal
approvals granted till date is 33,761
hectares out of which 50 approvals
are for state industrial development
corporations/state government
ventures, which account for 17,800
hectares approximately. No fresh
land acquisition took place for any of
these cases.
– Different states have their own land
acquisition laws. Some states also
have special land acquisition laws
for SEZs. The onus is on state
governments to put in place
reasonable and transparent land
acquisition laws for SEZs and
implement them effectively.
– SEZ developers are required to
provide for an adequate relief and
rehabilitation package for the
affected.
(Contd)
Economic and Political Weekly November 4, 20064536
– In Maharashtra, MIDC has come out
with a R&R package which includes
assured employment for members
of the displaced families and land at
concessional rates for them in the
developed area.
Loss of agricultural – SEZ will be built on prime agricultural – The general consensus in the board
land land with serious implication for of approval and state governments
food security. is that mainly waste and barren land
and, if necessary, single crop
agricultural land alone should be
acquired for the SEZs. If perforce a
portion of double cropped
agricultural land has to be acquired
to meet the minimum area
requirements, the same should not
exceed 10 per cent of the total land
required for the SEZs.
Misuse of land – Promoters will get land cheaply and will – To regulate usage of the SEZ area
for real estate make their fortune out of real estate by the developers, the SEZ board of
development and speculation approvals will assess the size
indiscriminately. The minimum required requirement of infrastructural facilities
processing area is 35 per cent. The rest like housing, commercial spaces,
will be for residential, recreational facilities. recreational amenities, etc, based on
the employment generation potential
of the SEZ. In the first phase it is
proposed to allow only a maximum
of 25 per cent of the approved
housing while the other approved
infrastructure will be allowed to be
created as per the developer’s plans
and as approved in the Master Plan.
The balance housing shall be
allowed to be established by the
approval committee in three phases
depending upon the progress in
allotment/occupancy of units in the
processing area.
Uneven growth – There is a strong possibility that SEZs – Almost every state will have SEZs
will be set up in states where there is under the policy. This will promote
already a strong tradition of infrastructure development and
manufacturing and exports. This will industrialisation in states such as
aggravate regional disparities. UP, Orissa, West Bengal
– The trend is already seen in the initial
approvals. The share of the four most
industrialised states (TN, Karnataka,
Gujarat and Maharashtra) in total
approvals is 49.5 per cent. Andhra
Pradesh, Kerala and Haryana account
for another 31.1 per cent of total
approvals. Thus seven states account
for 80.6 per cent of approvals. Their
share of in-principle approvals is
63.8 per cent. On the other hand,
industrially backward states of Bihar,
north-east and J and K do not have a
single approval.
Inequities – The incentives dished out to SEZs will – EOUs have the freedom of setting
create a tilted playing field between up their businesses anywhere in the
SEZ and non-SEZ investors. country and are enjoying the benefit
of DTA sales, which is not available
to zone units.
on how SEZs will affect the regional
economy, how much fertile land will
actually be lost, how many farmers will
be affected and what the tax implications
of SEZs will be. Most arguments are based
on the perception of officials. There is
therefore an urgent need to institute a study
(61 per cent) has been in the IT sector.
The manufacturing sector accounts for
only one-third of total approvals. This
pattern is worrisome. In view of the
declining competitiveness of the manu-
facturing sector, the focus of the SEZ
policy needs to be on making India a
preferred destination for manufacturing.
It is however encouraging to note that the
share of manufacturing SEZs in approvals-
in-principle is 69 per cent.
Furthermore, it is instructive to note that
SEZs do not embody dynamic forces that
can point towards sustainable development.
In the long run the competitiveness of
SEZs can be sustained only if economy-
wide investment climate is improved. This
is because zones cannot be insulated
from the broader institutional and eco-
nomic context of the country. The key to
successful industrialisation in the long run
thus lies in shaping the existing institutions
such that they drive firms towards an
outward orientation and technological
upgradation; the creation of zones
which offer the easy option of competing
on the basis of cost minimisation should
only be treated as a transitory policy arrange-
ment. Zones should not be considered the
best policy option for long-run industrial
development. Thus, the establishment
of EPZs should not be regarded as a
substitute for pursuing institutional and
infrastructural improvements.
Email: aradhna.aggarwal@gmail.com
Note
1 This is applicable to SEZ units who begin their
operations during the previous year relevant
to any assessment year commencing on or after
April 1, 2006.
References
Acharya, S (2006): ‘Essays on Macroeconomic
Policy and Growth in India’, Oxford University
Press, India.
Aggarwal, A (2006a): ‘Performance of Export
Processing Zones: A Comparative Analysis of
India, Sri Lanka and Bangladesh’, Journal of
Flagstaff Institute, 30(1), World EPZ
Association, Arizona, US.
– (2006b): ‘EPZs and Productive Diversification:
A Case Study of India’, ongoing study funded
by the World Bank.
– (2006c): ‘Impact of Export Processing Zones on
Employment, Human Development and
Poverty in India’, UNDP Working paper
(forthcoming).
Heeks, R (1996): India’s Software Industry, Sage
Publications.
on the socio-economic effects of SEZs
under consideration.
A Note of Caution
The sectoral break of SEZ approvals
shows that the largest number of approvals
Table 2: Arguments For and Against SEZs (Contd)
Issue Argument against SEZs Counter Arguments for SEZs
EPW