A Tale of Two Countries: SEZ-led Growth in India and China.

Author:Zhang, Isabel

After Chairman Mao's death in 1978, China began its transformation from a closed, impoverished nation to a liberalized, economic powerhouse, which it became in just forty years. With a GDP of $12 trillion USD in 2017, China is now the second largest economy in the world. (1) A critical factor in China's economic success was the 1980 creation of Special Economic Zones (SEZs). These areas allowed more relaxed business and trade regulations than the rest of the country, attracting foreign trade and investment. China's SEZs contributed significantly to its economy, accounting for 18.5 percent of national GDP and 60 percent of total exports in 2015. (2) After China's success, the Indian government, which liberalized their economy in 1991, adopted the SEZ model in 2000 to address its growing trade deficit and encourage export-led growth. (3) While India's special economic zones attracted foreign investment, they did not deliver a similar transformative impact as witnessed in China, as SEZs accounted for only 19 percent of India's exports in the first twenty years of establishment. (4) Several economic and political factors led to this discrepancy in SEZ effectiveness between India and China. For instance, India did not need to use SEZs to reform its economic system as it already had a liberalized economy. While SEZ managers in China were often motivated to promote long-term development, political expediency and corruption scandals hindered SEZ growth in India. Furthermore, local governments in charge of SEZs in China were given greater political and economic autonomy, allowing them to pursue policies adapted to the local economy, while SEZs in India were subject to numerous land and policy regulations at the national level. The success of SEZs in transforming China's economy can be attributed to their strategic role in the country's economic liberalization process; India's attempt at China's SEZ-led growth failed to achieve similar results due to the government's limited ambition to improve its economic policies, highlighting that the SEZ model is most effective when utilized as a component of larger, comprehensive economic reform. This paper compares SEZs in China and India by reviewing their performance differences and examining the reasons behind these differences, including policy objectives, decentralization of state power, and governance structure. Since SEZs have been most extensively used in China and India, the lessons learned from their experiences can be valuable to other developing countries seeking to implement SEZs.

Historical Background

In 1979, China established four special economic zones located in the coastal cities of Shenzhen, Zhuhai, Shantou, and Xiamen. Prior to the creation of SEZs, China was a closed, planned economy. Almost all factories and businesses were owned by the government, with neither private nor foreign ownership. (5) China had limited participation in the global economy, as trade share of GDP was less than 10 percent in 1978. (6) In experimenting with economic reform and liberalization during the early 1980s, China gave corporations in SEZs more economic freedom, such as the ability to pay workers floating wages and to create their own labor-contract system. (7) Although such practices were common in other countries, they were groundbreaking in China at the time because they were a shift away from the command economic system under Mao Zedong. In short, China used SEZs as test beds for implementing capitalism, described by Deng Xiaoping as "crossing the river, feeling the stone one at a time." (8) Beyond the relaxation of administrative rules, the Chinese government also offered specific financial incentives for foreign investors in the form of various tax "holidays." For example, SEZ enterprises were subject to a corporate tax rate of only 15 percent, versus the 33 percent tax rate imposed on joint ventures in the rest of China. (9) China also obtained advanced technology from foreign investors through joint ventures, where foreign business partners provided technology while the Chinese owners supplied buildings, sites, and equipment. By 1995, there were 9,000 joint ventures in Shenzhen, manufacturing more than 1 billion RMB (120 million USD) worth of products. (10)

Before 2000, India did not have SEZs and instead had seven Export Processing Zones (EPZs). Although these zones were also designed to facilitate foreign investment, the EPZs offered less economic incentives and had a negligible impact on India's economy. (11) India started economic liberalization in 1991 under Finance Minister Manmohan Singh. Before the process of economic liberalization began, India was one of the most protected and heavily regulated economies in the world, with little participation in the global economy. Singh's extensive reforms in 1991 caused policy changes in diverse sectors aimed to encourage greater private sector entrepreneurship and foreign trade. (12) Partly inspired by the economic success of China's SEZs, India introduced the "Special Economic Zones Bill of 2005" fifteen years later to develop zones on a larger scale. (13) The number of zones rapidly increased. By 2017, India approved 423 SEZs, with 221 already operational. (14) Similar to China, SEZs in India operated outside the domain of customs authorities, providing incentives for both domestic and foreign investors. For instance, SEZ units did not have to pay income tax for the first five years and were allowed to retain 100 percent of their foreign exchange earnings. (15) While both India and China envisioned SEZs as an instrument to promote economic growth and industrialization, the two countries considerably differed in zone performance.

The Importance of Fundamental Reform

Perhaps the most important reason for the diverging Chinese and Indian SEZ outcomes was their fundamentally different motives for establishing SEZs. After the death of Chairman Mao, under the leadership of Deng Xiaoping, the Chinese Communist Party intentionally moved away from a traditional communist economic model and created SEZs to support the broader goal of economic liberalization, using zones to experiment with capitalist policies. India, which had already liberalized its economy fifteen years before the creation of SEZs, only used zones to attract investment without an overarching purpose. Furthermore, while China absorbed foreign technologies through joint ventures in a broad set of industrial sectors, India's emphasis on the IT sector may have led to a lack of economic diversity within SEZs.

While China used SEZs to test market-based economic reform policies with the potential for nation-wide implementation, India used zones more narrowly to generate economic growth. In the late 1970s, the Chinese Cultural Revolution had just ended. The closing of universities during the Cultural Revolution created a dire shortage of highly educated personnel, which hindered China's ability to develop new and absorb imported technology, limiting economic development. (16) In response, Deng Xiaoping's "reform and opening up" (gaige kaifang) policy aimed to accelerate economic growth so that the economy would "surge forward" with the people "relatively well off." (17) Deng personally initiated the creation of four SEZs in 1979, in the cities of Shenzhen, Shantou, Zhuhai, and Xiamen. In just six years, these four zones attracted over one billion US dollars of investment, and contributed to over 20 percent...

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