Happy ending

Whatever the motivation, scrapping SEZs is the right thing to do

The government, if it is planning to do away with new special economic zones (SEZs), should do so immediately and not wait for six months to allow a New Delhi-based research institution to study the benefits that the initiative generated. Once seen as the country's answer to all the inefficiencies plaguing domestic producers, in reality the experience has been a combination of real estate speculation and a capture of fiscal incentives. When the policy was being devised a few years ago, critics of its final form argued that the one thing that was essential, but not provided for, was exemption from the job security commitments mandated by the Industrial Disputes Act - necessary to incentivise large-scale investment in the manufacture of goods for which India's labour abundance provided a huge competitive advantage. But that didn't happen, and so manufactured exports simply did not materialise. SEZs became alternative locations for IT and IT-enabled services exporters, who were hedging against the termination of other tax benefits under the software technology park scheme.

The imposition of a minimum alternate tax on units operating in SEZs further eroded the financial advantage they offered producers. This is highlighted by the fact that out of 577 approved SEZs, only 170 were actually operating. But, apparently, those that were operating took full advantage of the fiscal incentives on offer. Last year, exports from SEZs grew by almost 30 per cent, while aggregate exports actually declined by about two per cent! Such disparities raise questions about legitimacy and, in the absence of an effective surveillance and monitoring mechanism, should justify suspicions. This takes care of the finance ministry's concerns about fiscal incentives being misused. However, the commerce ministry's willingness to scrap SEZs, which it championed, needs to be scrutinised carefully. It appears that this willingness is based on its new pet initiative, the so-called national manufacturing and investment zones (NMIZs). The shift from general-purpose economic zones to a more focused approach to manufacturing activity could have some benefits, with, for example, greater emphasis on the kinds of infrastructure that manufacturing is most dependent on. But, like before, better infrastructure will have only a limited impact on competitiveness without the fundamental constraint of job security regulations being addressed. In the absence of this reform, NMIZs are truly old wine in new bottles.

If the government is serious about promoting manufacturing, then surely it must also begin to tackle the binding constraints at a national level. During the debate on SEZs, it was argued that India could not follow the "one country, two systems" approach that China and, earlier, Malaysia had done in setting up their very successful zones. But the more relevant precedent, perhaps, is Korea, which also set up zones, but saw very little export from them. Why? Because their strongest export incentives were available throughout the country, not just in the zones.