Repeating a mistake

'Special zones' are no substitute for structural reform

India’s long obsession with the notion of special economic zones, or SEZs, is likely to be given a fresh lease of life. According to a report in this newspaper on Monday, two “coastal economic zones”, or CEZs, are being planned, one in the western state of Gujarat and another in the eastern state of Andhra Pradesh. The report suggests that enterprises in these CEZs will be able to take advantage of a decade-long “tax holiday” —  that is, they will not have to pay corporation tax for 10 years. In return, they will have to meet certain minimum employment targets. The idea, of course, is to incentivise companies to take advantage of the ports in the CEZs and set up manufacturing units that provide jobs. It is important to note that the CEZ proposal has some significant differences from the various other iterations of the idea —  SEZs, export promotion zones, and so on. For one, the CEZs are planned to be around 450 kilometres long, with direct access to deep-water ports. Many previous schemes did not work out because the zones set up under them were too isolated or could not take advantage of economies of scale. Hopefully, those particular problems will be avoided in this case.

But the larger error in thinking has unfortunately been replicated. If an SEZ or a CEZ is to make sense, then it should be able to stand on its own. It should be a competitive destination for manufacturing even without tax breaks. The Indian experience has consistently been that SEZs are treated merely as a source of tax deductions; and so they do not add that much to national income, merely divert production from elsewhere while reducing government revenue. This is partly why the exemptions for existing SEZs are being phased out. One of the most forward-looking tax proposals from the current government was to close loopholes in the corporate tax system while reducing the headline tax rate. Ending the SEZ exemptions, in particular, was a crucial part of that mechanism. Including a tax holiday for CEZs in the next Budget would go against that sensible, progressive logic. Hopefully, wiser counsel will prevail in the months that still remain before the Budget is finalised.

The tax exemption conundrum apart, the larger question remains: Why should the focus be on special zones instead of more general reform? The renewed focus on special zones is nothing more than an admission of defeat by the Union government. It is an open acceptance that its attempts to reinvigorate the manufacturing sector on an all-India scale are not working. This administration was elected to reinvigorate the economy and to deliver jobs. But was it elected to deliver jobs only in stretches of two states? If it is to live up to its mandate and to the promise of the ‘Make in India’ campaign, then the government needs to look again at the structural reform agenda that it has put on the back burner. Reform of labour and land law as well as comprehensive deregulation remain the pre-requisites for Indian mass manufacturing to develop. Without legal changes, yet another attempt to ring-fence special zones will fail just as badly as the many attempts made over the past decades.