The Indian Economy Blog

September 25, 2006

SEZs: Even More Confused

Filed under: Business — Edward @ 9:48 am

A couple of weeks ago I put up a post about the controversy surrounding India’s attempts to create Special Economic Zones using some sort of ‘home grown’ variant of the Chinese example. In the end I thought I understood what it was that was bothering people, but then I read this piece in the Financial Times and discovered that Sonia Gandhi is now wading in against the idea, although  obviously with an entirely different set of objections.

Since the passing of the Special Economic Zones Act in February, hundreds of businesses have rushed to take advantage of generous tax breaks, causing consternation in the finance ministry, the central bank and even the International Monetary Fund.”

This would be Raghuram Rajan that the FT  are talking about, and the consternation refered to here would be one associated with the way the tax breaks were being allocated, and who they were being allocated to, and this concern I fully understand (as I say in the post), but it is not an argument against SEZs *in principle*, only about the way the ones which are presently in preparation are envisioned and administered.

But then along comes Sonia:

In a speech on Saturday, Mrs Gandhi, a key influence on the government, said farmers were being unnecessarily displaced by SEZs. So far, 150 SEZ projects have received formal approval and 117 “approval in principle”.

“Prime agricultural land should not normally be diverted to non-agricultural uses and, even if this was resorted to for unavoidable reasons, this should not jeopardise agricultural prospects,” she told chief ministers of Congress party-ruled states.

Now I’m at a loss here. Again this is not a critique of SEZs in principal, but is there really such a shortage of land in India? I mean maybe a zone would be better here rather than there, but wherever you put it some people are going to be inconvenienced and displaced, is this a debate about levels of compensation?

In comments on an earlier post Nandan Desai raises this important point:

The old problem of ‘concentrated costs, diffuse benefits’: In a democracy, the voices that will be heard in a particular debate……… are obviously the ones which are most-effected by a particular piece of legislation (in this, say the domestic farmers at risk of displacement by an FTA). Since the costs of the legislation are concentrated in this small group, but the benefits spread over an entire population, the small group will obviously lobby a lot harder against the legislation, than all of us will lobby for it.

I suspect what we have here is a clear case of what Nandan is talking about. In the process of economic development there will obviously be winners and losers, unfortunately there is no avoiding that.

I would say one of the biggest legitimate issues which I have seen in the debate concerns size:

But economists believe the proposed SEZs are unlikely to help Indian manufacturers achieve scale efficiencies, since 133 of the 267 are less than 1 square kilometre in area. The average size is just 4.2 sq km.

“Mega-sized SEZs are the ideal solution,” said Chetan Ahya of Morgan Stanley. “We believe that in today’s highly competitive globalised world, the concept of small-sized SEZs is completely outdated.”

Probably Chetyn Ahya is right here, and in respect to the difficulties involved in getting agreement to make them big enough, Nandan is surely right, as Kamal Nath suggests:

In a Financial Times interview, Kamal Nath, commerce minister and champion of the SEZ scheme, said the combination of high population density and democracy made it impossible for India to follow the Chinese model of giant export-oriented manufacturing zones.

This may well be, and there are both positive and negative connotations to the use of the term ‘democracy’ here, the negative ones being associated with the idea that ‘democracy’ sometimes enables small groups of well-organised vested interests to effectively block things. Of course India isn’t China, and development will be different in India, but this having been said some of the same issues will arise, and where to locate the SEZs would seem to me to be an illustration of this, especially in one underlying point which doesn’t seem to be being explicitly addressed: do you take the SEZs to the people, or do the people move to the SEZs? I have a feeling this is the unspoken heart of the problem.

17 Comments »

  1. Hi Edward – Interesting debate. Going beyond the theoretical aspects (i.e. needs of many outnumber needs of few, there are bound to be losers, etc) of the debate which probably apply to any major economic development anywhere in the world (for eg China), I am looking forward to answers to the “heart of the problem” you defined in those 2 questions.

    Also – I’d appreciate your thoughts on the potential (actual?) land-grabbing that politicians/corporates, etc indulge under the garb of acquiring land for SEZs. I understand this is not linked to either of the two posts you’ve done so far. Thanks.

    Comment by Bombay Addict — September 25, 2006 @ 10:12 am

  2. Bombay Addict

    “I am looking forward to answers to the “heart of the problem” you defined in those 2 questions.”

    I wish I had them. I am learning here, which is why I am using titles like “Even More Confused”, this is not all irony, I am not in India, and I am looking for insights that others may have to offer.

    “I’d appreciate your thoughts on the potential (actual?) land-grabbing that politicians/corporates, etc indulge under the garb of acquiring land for SEZs.”

    Well obviously this is happening, and this I imagine is what it uppermost in Raghuram Rajan’s mind. But again it is hard for me to tell from here to what extent this is an issue.

    Obviously opponents of the idea from within the Sonia Gandhi camp will emphasise this part, while at the same time implicitly defending all the abuse which already goes on on a daily basis. I mean, nothing here is ever going to be easy. You are not going to eliminate corruption overnight, so the pragmatic view would be to see whether, on balance, things were better after than before.

    All of this is, at the end of the day, tied to communications and infrastructure. These things need to be where the products can be moved around easily, and, if need be, globally. This suggests that to some extent at least the people need to go to the production rather than the production to the people.

    So one of the issues is that with the State structure some states are going to try and resist the accelerated development of some States as against others.

    I’ve seen reference to the idea that there is a growth corridor running across India. It is going to be hard to avoid that.

    The thing is to let the most dynamic grow quickly, and then use the central administration work to redistribute the benefits to some extent. No useful purpose is served by keeping everyone poor.

    Here in Spain I am in Catalonia. We are constantly protesting here about our ability to grow is constantly restrained by stupid rules from the centre which are often imposed under pressure from other areas which are threatened by our growth. The latest example is the airport, which could under local control and could raise private money to build another runway to faciliate inter-continental flights, but we are no allowed to do this since it might attract traffic and growth from other areas. So India is far from alone here (same with politial influences over building permits).

    Comment by Edward — September 25, 2006 @ 3:12 pm

  3. Please answer the following points.

    1) It is my contention that the manufacturing and services sectors do not need any incentive from the govt. to setup shop in India.

    2) Simply lifting restrictions on landuse, that is, making it possible for businesses to buy lands directly from the landowners, for whatever purpose they might choose, will result in the following benefits.

    - The landowners will get a competitive rate for their land, and hence they’ll be happy to sell their land.

    - The buyer is having to pay the full rate for land, hence there is going to be no undue benefit accorded to any one company, which is good thing. It will promote competitiveness, and the best guy wins.

    - The company that sets up the complex will pay tax, so government will also benefit.

    - In the situation that a manufacturing unit is causing too much envronmental damage, for example, it can be shut down.

    I am suggesting that an SEZ is just an extension of the license quota regime. And for that reason, I suggest that SEZs be dismantled. Why this special previlege to some particular companies?

    Secondly, I am arguing that an SEZ reduces government control over its own territory, which is not always a good thing. The government must be in a position to intervene for the welfare of its citizens. Does it retain that ability in the case of the SEZs?

    Comment by Karthik Rao Cavale — September 25, 2006 @ 5:32 pm

  4. Hi again Karthik,

    “Please answer the following points.”

    Well this is pretty much a rerun of the debate we had on the earlier post.

    “It is my contention that the manufacturing and services sectors do not need any incentive from the govt. to setup shop in India.”

    I can’t really answer this since it isn’t a question. It is your contentition, and you are perfectly entitled to your view, but it is my contention that they do (need incentives that is), at least the kind of economic activities you want to see do need incentives and encouragement (for all the reasons I explained on the previous post). The real debate is about what kind of incentives will prove to be the most effective. Infrastructural ones (like roads and ports, and power networks) certainly help.

    “Simply lifting restrictions on landuse, that is, making it possible for businesses to buy lands directly from the landowners, for whatever purpose they might choose, will result in the following benefits.”

    Again, this is not a question, but an opinion, and again fine, but again I am entitled not to agree.

    In particular this part:

    “Simply lifting restrictions on landuse…..The landowners will get a competitive rate for their land”

    Well, not exactly, since it is the land use certificate which regulates the price of the land. What you say would be the case if there were no land use restrictions whatsoever, then landowners could bid with each other to attract purchasers, but since this is impossible then those who get the change of use also get an economic rent, and they know it.

    “Secondly, I am arguing that an SEZ reduces government control over its own territory, which is not always a good thing. The government must be in a position to intervene for the welfare of its citizens..”

    This I think is your main point, but I don’t think this in any way need form part of an SEZ, I don’t think it is an inherent component of such zones that the government need surrender all rights, all they need to do is create a special status, and the exact nature of this special status is what is negotiable, and is what forms the core of any particular package of measures in practice.

    Comment by Edward — September 25, 2006 @ 11:02 pm

  5. Indian model of SEZ is very confusing. These mini SEZ’s are just to attact and create buzz. The true concept of SEZ is to create high levels of efficiency in mass production by creation of huge industrial zones. In china for example the Shenzen SEZ produces and exports items equivallent to the total export by India for a given year.

    Indian mini SEZ’s are filled with political tactics and strugle. The states want the SEZ to be in their state for ther to be more development. And the commerce and finace ministry is strugling to agree on things like the tax exemption given.

    Anyways let us hope that some SEZ is always better than no SEZ at all..

    Comment by shikhil — September 25, 2006 @ 11:03 pm

  6. I think the reasoning behind the critique of SEZs goes beyond the realm of ‘concentrated costs-diffuse benefits’ because at least in this case, the (potential) costs are certainly not concentrated. By according a more favorable policy environment to a particular area, how the private sector allocates resources changes drastically, and unless it is accompanied by an overall effort to improve competitive conditions outside the zones, it will naturally create short and long term distortions in the marketplace – and impose fiscal costs on the rest of the economy. So the key question and the operating metric by which their success is measured should be: is the economic benefit that SEZs afford to the rest of the economy (ie. NOT the zone itself) large enough to outweight the direct and indirect costs of maintaining the zone’s priveleges?

    My view is that, without near flawless implementation (which I will define momentarily), the answer is ‘No’ and the zones will invariably end up creating pockets of wealth at the expense of the rest of the economy.

    For an SEZ to be implemented well (ie. for the benefits from it to outweigh its costs), a number of things have to be done. Listed approximately by importance:
    (1) There has to be the political will for the SEZs to be only a part of the reform puzzle. They cannot be seen by the policymakers as a substitute to creating a good investment climate, but as natural complements. The direction and approximate magnitude of regulatory change in the SEZ and the society at large has to be similar.
    (2) There have to be strong domestic and international linkages (both through hard and soft infrastructure) for the SEZs to be open and succeed (choosing locations is part of this).
    (3) The design of the SEZ’s regulatory framework and its administration has to be rock solid (ie. conform to int’l best practices, be transparent, etc.)

    If one or more of these conditions aren’t met, then the benefits in terms of job creation, FDI, growth, forex, and technology/skill transfers will be short-term and yet a considerable amount of revenue will be lost. If they are met, then they are indeed very promising. So the devil here is essentially ALL in the implementation of the policy.

    This is where the China-India comparison comes in. Central planning and the ability to effectively mobilize resources makes China very good at implementing these international best practices (most of the time) in their zones. On the other hand, India’s governance (both national and state) is notoriously weak — and, even though I am a huge believer in the ‘India story’, I am cynical and realistic enough to know how badly these kind of things tend to be implemented in India. In this sense, I would say that a lot of the recent criticism of SEZs is justified and very much needed.

    However, joining this chorus puts reform-minded Indians like me in the awkward position of being ‘For the SEZs, but against the way theyre implemented.’ (Not very different from John Kerry in 2004 on his views on the war in Iraq).

    Edward, unlike other problem which can be attributed to the vagrancy of vested interests, this one might well be the exact opposite – ‘concentrated benefits, diffuse costs’.

    Comment by Nandan Desai — September 25, 2006 @ 11:42 pm

  7. I think Shikhil’s comment illustrates my point.

    Without sounding patronizing, I think we are having the wrong debate here. When one asks, “Are SEZs good or bad?”, the operating question we are essentially asking is “What is the appropriate role of the government in the economy?” and the SEZs are merely the context.

    My sense is that there is relatively broad agreement in India (amongst the population – NOT the politicos) that a free market is indeed a more effective market. I think most educated people will come to the same conclusions about the reforms needed to achieve this within about 10 degrees. However, by arguing only the merits of the policies, we end up forgetting about implementation – which in turn demerits the policy… creating a vicious cycle.

    I wish for once that Indians could get beyond the debate, and learn to focus on and realize the importance of good execution.

    Comment by Nandan Desai — September 25, 2006 @ 11:55 pm

  8. I didn’t phrase my comment properly. I wanted to ask you to disprove my contentions.

    “What you say would be the case if there were no land use restrictions whatsoever, then landowners could bid with each other to attract purchasers, but since this is impossible then those who get the change of use also get an economic rent, and they know it.”

    Exactly! Why encourage people to make money out of what is essentially a process of bribing govt. officials to get this change of landuse approved? Why do you prefer this over a uniform policy in which anybody is allowed to use his lawfully owned land as he pleases? Doesn’t it remind you of the license quota regime in which a few companies made huge profits out of govt. patronage while the rest were not allowed to compete at all?

    If I remember correctly, these are the reasons you gave justifying incentives to the services and manufacturing sectors.

    “For the simple reason that industry and services are India’s future so they are worth subsidising to get them going (and to provide employment for the people displaced from agriculture), agriculture (in its present form) is India’s past and needs closing down, or at least ‘rationalising’ and industrialising enormously.”

    Here’s my question. Is there any reason to think that our private sector any longer lacks the capital? Or is it that business in India isn’t safe enough? Or is it not profitable enough? If it weren’t profitable enough, you would agree that it ought not to be encouraged. If neither of the remaining two is the case, then why is it that industries don’t spring up spontaneously?

    “Infrastructural ones (like roads and ports, and power networks) certainly help.”

    Certainly. And the government must concentrate on this work. For the benefit of all. All citizens, all companies.

    Even if I were to accept that incentives are required, why should the incentive go to one particular company alone?

    Fine, let’s accept that additional employment is the main attraction of an SEZ. Have you analysed any kind of cost-benefit analysis from the govt. point of view before coming out in support of SEZs? How do you monetarily fix the benefit of greater employment? Can you show us, even approximately, that this value exceeds the loss in terms of tax generation, compensation to displaced people etc.?

    Comment by Karthik Rao Cavale — September 26, 2006 @ 12:26 am

  9. Karthik,

    By in large, I agree with your analysis and do believe that, given the pathetic state of governance in India right now, we are better off without SEZs. Instead, we should maintain our focus on nationwide reforms.

    What I was trying to point out was that, under certain conditions (basicallly, good design/implementation), the cost-benefit can be beneficial because of multiplier effects of exports, forex earnings, etc. so SEZs aren’t inherently bad – they’re only bad in India.

    Comment by Nandan Desai — September 26, 2006 @ 12:58 am

  10. The govt. owns so much land, why not set up sezs in that?

    If the compensation is going to be money and land, and if the govt. land is useless for setting up sezs, how do you expect people to accept those lands as compensation?

    If the compensation is going to be money and employment, what job do you think will be given to a bunch of uneducated farmers?

    If the compensation is going to be only money, god help those people.

    The govt has land, and if it has the will, it will create the infrastructure. But no they will not do anything sensible instead they will go for shortcuts, like what they are doing now. And what will happen is, it will only help the LEFT. Then you can see what good they will do.

    Comment by Senthil — September 26, 2006 @ 8:51 am

  11. Yes, I do agree that the Indian model of SEZ is very confusing. I visited the SEEPZ facility yesterday, which is now a SEZ under the new dispensation. I dont see any distinction between the old & new versions impacting business decisions. The tax incentives are driving the new wannabe SEZers. There does not seem to be any effort in improving the infrastructure (factory sheds/ roads/ logistics/ access) which have been added recently. I have been going to this place off and on for more than 15 years, and it is supposed to be the one SEZ contributing more than 50% to the exports from SEZ’s today !

    IMHO, this is primarily a land-grab play today. Adjoining parcels are being positioned by ‘insiders’ and sold off once it is notified. The few serious ones where FDI/ serious corporate investment interest is there are ones which would come up. But the intent of the SEZ’s was to facilitate the SMEs, who today constitute more than 50% of indian exports, to be more competitive. Where is that in all this heat & dust one doesnot know ?

    But one thing is for sure, it has generated lot of interest domestically and internationally on the state of improving manufacturing and infrastructure. So in the serendipitous way the ‘market’ in its own way may shed some light on how it would generate the externalities

    Comment by envenkat — September 26, 2006 @ 10:23 am

  12. Karthik,

    OK, first off thanks everyone for some thoughtful and interesting comments. I don’t think there is any right answer here, only issues.

    “Why do you prefer this over a uniform policy in which anybody is allowed to use his lawfully owned land as he pleases? ”

    Well simply because I do think there is a need for rules and regulations in this area. Let me put it like this, right now they have just knocked a builing down right across the road from where I am writing. Ideally I’d prefer that they left it down, since there is more light, but I recognise that in the nature of things that can’t be, and that they will obviously build something. I am, however, reassured that we have land use regulations and that they won’t build a small industrial workshop to keep me awake at night. This system isn’t perfect, I know, since even here the ability to award planning permission is what allows the political parties to finance themselves.

    “Here’s my question. Is there any reason to think that our private sector any longer lacks the capital?”

    No, I agree, that isn’t realy the issue. It is what the capital will be invested in which is the question.

    You see there is a more technical economic point in play here, and it has to do with the findings of what is known as the ‘new economic geography’ (Krugman in particular) and the existence of a phenomenon known as ‘increasing returns’.

    Basically the economic landscape isn’t a flat surface. It is more like Mars, with craters dotted about all over the place. Now you could imagine existing economic activites as being concentrated in one or two craters, and the new activities you want to stimulate as being currently emply craters.

    So what you want to do is encourage people (enterprises) to move into the empty craters. But this has economic costs, since first you have to be able to get up the steep wall from where you are before you can descend the slope into the next one. The issue is, who pays these costs?

    Left to themselves many businesses are unlikely to do this, since profitability may be greater where they are, they simply need to expand sideways.

    The costs involved are not only infrastructure, they are also to do with generating the necessary human capital, this is a heavy initial cost. Indian IT got off the ground so quickly because part of this cost was carried in California. But the next time, and the next, it won’t be so easy. This is why I think these activities need to be subsidised and encouraged. Of course all this needs to be done with a certain degree of rationality, and it is here we seem to have the problem.

    A good example of this lack of rationality is the debate which is currently going on in Karnataka about English language schools (I’m about to post on this).

    Nandan

    “What I was trying to point out was that, under certain conditions (basicallly, good design/implementation), the cost-benefit can be beneficial because of multiplier effects of exports, forex earnings, etc. so SEZs aren’t inherently bad – they’re only bad in India.”

    I think basically we agree about this, the way this is being done in India is wholly inadequate right now, but can we be happy that it stays like that? Can SEZs be bad in India permanently? I think not. If India is to become a developed economy then it has to achieve the political maturity necessary to have SEZs.

    “I wish for once that Indians could get beyond the debate, and learn to focus on and realize the importance of good execution.”

    This is really the point.

    Shikhil

    “Indian mini SEZ’s are filled with political tactics and strugle. The states want the SEZ to be in their state for ther to be more development. And the commerce and finace ministry is strugling to agree on things like the tax exemption given.”

    Yep, this would seem to be the point. This needs a national not a state perspective (assuming that is, and this is in itself a very interesting question, that India is a ‘nation’. It is a nation state, but is it a nation?).

    Envenkat

    “I have been going to this place off and on for more than 15 years, and it is supposed to be the one SEZ contributing more than 50% to the exports from SEZ’s today !”

    Thanks for this insight. Very interesting.

    “But one thing is for sure, it has generated lot of interest domestically and internationally on the state of improving manufacturing and infrastructure. So in the serendipitous way the ‘market’ in its own way may shed some light on how it would generate the externalities.”

    Yes, this is my sentiment entirely.

    Comment by Edward — September 26, 2006 @ 4:21 pm

  13. Well, you did not answer one question that I asked you. Don’t you agree that an SEZ is a concession to one particular private party, and hence creates a kind of unfair competition? Do you think this is a good thing?

    Comment by Karthik Rao Cavale — September 26, 2006 @ 5:13 pm

  14. Karthik

    “Well, you did not answer one question that I asked you. Don’t you agree that an SEZ is a concession to one particular private party, and hence creates a kind of unfair competition?”

    Well look, as they are being implemented now this may well be the case, and as such this is not a good thing. But it doesn’t *have* to be like that, this would be my point.

    Comment by Edward — September 26, 2006 @ 10:54 pm

  15. SEZ’s are nothing but tax free areas which are promoted by businessmen and the advantages shared with the politician. Why shud only a, b, c area be developed, allow all areas to develop and dont give the business man any additional tax breaks. if he does not invest someone else will

    Comment by Neville — October 2, 2006 @ 3:46 pm

  16. The SEZ policy in China was needed so that a communist state could experiment with capitalism on a small scale. It is clearly not needed in democratic India. The key drivers of the policy seem to be tax breaks and government acquisition of land – both of which are not justified, particularly if applied in a discretionary manner (through a restriction on the number of SEZs). The only reason for India to have SEZs is to introduce labor flexibility in restricted areas, and this is not being done in the current policy. For more on my views, please see this

    Comment by Unknown Indian — October 7, 2006 @ 4:35 pm

  17. Of coure India has taken cue from chine for setting up its SEZs, but the intensity of governance, monitoring and regulations are so poor that its really and seriously doubtful as to whether India will be able to reap the same kind of benfits like china. The fears being expressed by the people like Montek Singh Ahluwalia and our finance Minister Mr. Chidambaram are well founded that the SEZa in India are more likely to becvome real-estate hubs. After the allotment of lands in different States SEZs establishments are more likely to take things in their own way slowly and slowly and the Government will lose control over its regulations. Moreover no one knows whether we in India are also following the same criterian in the establishment of SEZs, the way it has been done in china. How the China has achieved thundering success in their SEZs is required to be studied more closely and followed more scrouplously. Better it would have been to set up only few SEZs on experimentation basis and regulate watch those fews ones very closely to have the desired and expected results, rather than allowing the setting up of whole lot of SEZs in one go without having any formulated plans of their regulation for the desired results.

    Comment by vijay kumar — October 23, 2006 @ 1:12 am

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