If You Build It, Will They Come? How Institutions Matter in Economic Zones and Development in Southeast Asia

(This piece was written with the intention of simply recording my thoughts on the ABIS 2017. As somewhat more of a reaction paper than a real think piece, the analysis is rather light and not much effort was placed on showing supporting data. Fair warning.)

During the ASEAN Business and Investment Summit (ABIS) 2017 in Manila, the ASEAN Secretariat and the United Nations Conference on Trade and Development jointly launched the “ASEAN Investment Report 2017: Foreign Direct Investment and Economic Zones in ASEAN.” It once again shines the spotlight on the important role economic zones play in attracting investments, facilitating trade and generating employment among ASEAN member-states to spur industrial development. In general, economic zones are demarcated areas where industrial facilities, infrastructure and streamlined regulatory and administrative regimes are made available for the exclusive use of industries within the zone. This definition covers similar terms such as industrial parks, special economic zones, export-processing zones with minor differences in incentives offered according to their specific objectives.

In Southeast Asia, there are more than 1,600 registered economic zones since the first development in Singapore in the 1960s. However, economic zones track record in the region have been mixed. While there are well-known successful cases such as Singapore’s Jurong Island in constructing the foundation of its heavy industrialization push, many economic zones in the region have been disappointing to say the least. Infamous cases of failed developments include those that are practically empty like the Philippine’s Aurora Pacific Economic Zone and Freeport (APECO) and those like the Bataan Export Processing Zone (BEPZ, now Bataan Freeport Area) whose incurred costs (government subsidies, tax breaks, etc.) are larger than its benefits (employment generation, local input purchases, etc.). Given the variation in outcomes, what determines the success or failure of an economic zone?

Different Institutional Capacities, Different Arrangements: The Case of Singapore, South Korea and the Philippines

The first order difference between successful and failed economic zones in the region are mainly in terms of the capacity and the role the institutional authority governing economic zone development and operation play. Some models have the institutional authority serve as both regulator and developer/operator of economic zones such as Singapore’s Jurong Town Corporation (JTC), South Korea’s Korean Industrial Complex Corporation (KICOX) the Philippine’s Aurora Pacific Economic Zone and Freeport Authority (APECO) while others keep the institutional authority in a regulatory role and leave development and operation to the private sector such as the Philippine Economic Zone Authority (PEZA).

Best practice institutional arrangements indicate that government regulators and developer/operators should be separated to reduce government risk, political interference and take advantage of private sector expertise. In the Philippines, PEZA who lacks technical expertise in management is limited to a regulatory function where it decides incentives and approves investments while the private sector develops and operates economic zones. Evidence indicates this model has worked relatively well as PEZA has attracted over 3,000 locators and generated over 1.2 million jobs. In contrast, APECO is both regulator and developer/operator of the freeport zone in Aurora. Because of poor location planning directed by political rather than economic logic, APECO has failed to attract locators and firms to set up shop in the area despite a government investment of PHP2.9 billion.

However, this preferred arrangement assumes that all government institutional authorities are incompetent like APECO. By ignoring variation in government capacities, it effectively foregoes advantages afforded to fused regulator and developer/operator roles that characterizes much of the East Asian experience. In Singapore, JTC, a statutory body under the Ministry of Trade and Industry (MTI), is both regulator and developer/operator of economic zones. It is composed of highly competent professionals in real estate development and management. Its status as a statutory body under the MTI allows for better coordination between economic zone development and national economic priorities. For example, in the 1970s, JTC developed Jurong Island according to Singapore’s economic priority of shifting towards higher value-added heavy industry of petrochemicals. In South Korea, government organisation KICOX re-programmed its national industrial complexes it solely owns using a hub-and-spokes model to achieve dynamics gains in industrial agglomeration, clustering and university-industry innovation linkages after completing its catch-up industrialization strategy.

Institutional authorities with strong capacities in terms of technical and development skills such as in planning and management are best to play both regulator and developer/operator roles of economic zones. This fusion of roles allowed for a more efficient management, configuration and re-configuration of a critical mass of economic zones and industries within them to drive their rapid industrialization and development according to evolving economic conditions and priorities of the last four decades.  

Success and Failure: Beyond Fiscal Incentives and Static Gains

The success of economic zones must not be judged on static benefits alone such as investment attraction and employment generation that are often limited inside these zones. Most critically, dynamic gains such as innovation facilitation, technological transfer, and skills upgrading are what economic zones can contribute to genuine wider domestic economic transformation.

Cases like APECO that are also abundant in countries like Vietnam are evidence that static gains, much less dynamic gains, do not automatically follow by simply building economic zones and pouring incentives. Public sector risks are further exacerbated in the absence of a strong periodic impact assessment that lead to opportunities for abuse at the expense of public finances that could have been used for other development programs. For example, the Philippine National Tax Research Office reported in 2013 that PEZA-registered firms received PHP108 billion worth of fiscal incentives while remitting only PHP523.5 million to the National Treasury. Proper planning, robust demand assessment, appropriate infrastructure and one-stop services provision, upgrading programs and capacities of local firms and workforce matter more than tax breaks and incentives for long-term sustainability and competitiveness of economic zones.

Further, by differentiating between static and dynamic gains, the impact of variation of institutional capacities and arrangements become more apparent. While PEZA has been relatively successful in securing static gains of investment attraction and employment generation, it has been less successful in achieving dynamic gains like forward and backward linkages with the domestic economy or driving economic restructuring. This compared to JTC and KICOX that have played critical roles in facilitating new industries and continuous domestic technological upgrading to create the advanced industrial economies of Singapore and South Korea today. Variation in these cases suggest there are significant limits to a private sector-led model of economic zones whose many diverse commercial logics may not necessarily coincide with national economic priorities.  Regulation, development and management by a single highly capable governance institution simply make it easier and more efficient to program and re-program a critical mass of economic zones according to evolving economic conditions and imperatives over time to drive economic restructuring and industrialization.    

	Fusion of Regulator and Developer/Operator Roles	Separation of Regulator and Developer/Operator Roles
Weak Institutional Capacity	Static Gains (PEZA)	Limited Gains (APECO)
Strong Institutional Capacity	Dynamic Gains (JTC, KICOX)

Conclusion

Policymakers in many Southeast Asian countries have a misguided belief that if you build economic zones with abundant incentives, investment and employment will automatically come. The case of APECO and many other similar cases of weak institutional capacity and fused regulator and developer/operator roles often succumb to irrational planning and decision-making incurring massive costs without desired benefits. At the same time, however, policymakers need to take best practice institutional arrangements with a grain of salt. In the context of strong institutional capacities, dynamic gains are better secured by institutional arrangements that fuse regulatory and developer/operator roles in a single institutional authority. While a private sector led economic zone program may be desirable in contexts of weak institutional capacity, Southeast Asian countries ought to aspire more towards the development of high capacity and quality governance institutions to unlock the dynamic potential of economic zones for development.