Static Economic Outcomes

The basic principle to attract significant quantities of local and foreign investment to SEZs continues to be designing specific public policies applicable solely within these zones, which serve as major incentives for appealing to companies. The different types of incentives that have been given to both local and foreign companies can be summarized as follows: a) preferential treatment when it comes to taxes, cost of land, loans, credit, etc.; b) greater freedom for investors in terms of earnings and ownership; c) local supply and advantages for cheap labor, infrastructure, services, etc.; d) administrative advantages in the zones to simplify and unify formalities (^{Li, Whitwell & Yao, 2005}; ^{Wong & Chu, 1984}).

In the case of Mexico, the Secretariat of Finance and Public Credit has announced that companies and individuals doing business and investing in SEZs shall be entitled to a 100% discount on paying the Income Tax (ISR, in Spanish) during the first ten years and 50% for the next five. To these incentives are added others pertaining to credit and administrative facilities, and special treatment when it comes to the Value Added Tax (VAT), primarily.

Incentives of this sort have fulfilled the goal of attracting significant investment to the majority of the economic zones implemented around the world (^{Li, Whitwell & Yao, 2005}; ^{Schweinberger, 2003}), so much of the specialized literature related to this topic has focused on explaining the dynamics of Foreign Direct Investment (FDI) after it arrives to the zones, as well as measuring its direct impact on the economic growth of regions where this investment ends up, and on the neighboring municipalities or regions.

Such is the case of the SEZ model implemented up and down the coast of China, one of the most-studied systems in the world. Beginning with the economic reform kicked off by Deng Kioping toward the end of the nineteen-seventies with the Open-Door Policy, China became one of the top recipients of FDI, flowing principally from Hong Kong, Taiwan, the United States, Japan, and Singapore (^{Liu, 2002}). In 1980, the first SEZs were launched in the cities of Shenzhen, Zhuhai, and Shantou in the province of Guangdon, followed by Xiamen in the province of Fujian. By 1984, these cities had annual average GDP growth rates above the 10% national rate: Shenzhen grew at an annual average rate of 58%, followed by Zhuhai (32%), Xiamen (13%), and Shantou (9%). This astonishing growth in the four SEZs was in large part due to FDI, which at the endo f 1985, represented 20% of the national total. By 2007, FDI in the country's most significant economic zones amounted to 46% of the national total (^{Zeng, 2010}).

This principle was corroborated in a more recent study, designed to quantify the impact of the SEZs and explore the mechanisms by which they yield effects. To do so, ^{Wang (2013)} compared the changes across 321 Chinese municipalities with an SEZ before others between 1978 and 2008. The results demonstrated that the SEZs had an overall positive effect on investment, that the introduction of this model on average significantly raised FDI by 21.7% per capita, and that the FDI growth rate was 6.9 percentage points. Moreover, looking at the dynamics of where investments and their companies were located, the study concluded that the economic zones model increased FDI, but not at the cost of relocating existing companies or investments; and, finally, that the new FDI did not displace domestic investment.

The FDI flowing into various developed zones in Africa, Asia, and Latin America has also entailed a first step for the success of this program, because it has created jobs, boosted exports, and provided the possibility for structural change. In the time period 2000-2008, FDI in the zones as a percentage of total FDI received in Vietnam, Ghana, Bangladesh, Tanzania, and the Dominican Republic amounted to 100, 48, 30, 18, and 18%, respectively (^{Farole, 2011a}).

In the case of Mexico, it is evident that the states in the zone in question face challenges in attracting FDI. In 2015 alone, the states of Chiapas, Guerrero, Michoacán, Oaxaca, and Veracruz were among those with the lowest levels of FDI in Mexico, at just 0.46, 0.53, 1, 0.76, and 5.07% of total domestic FDI, which in that same year amounted to 30,284.6 million dollars (^{Centro de Estudios de las Finanzas Públicas, 2016}).

The second static economic outcome to which SEZs have made a salient contribution is bound up in employment and exports. Beginning in the nineteen-seventies in East Asia and Latin America, the economic zone programs were designed to attract investment from labor-intensive multinational corporations (^{Farole, 2011b}). In 2008, there were approximately three thousand economic zones spread across 135 countries, generating over 68 million direct jobs and over 500 billion dollars in direct commercial added value within the zones (^{The World Bank Group, 2008}).

In China, in 2006, total employment in the four initial SEZs was around 15 million jobs, representing 2% of national employment (^{Zeng, 2010}). For its part, in the Dominican Republic, the EPZs enable the creation of 100,000 manufacturing sector jobs, helping the country move away from its reliance on agriculture (^{Farole, 2011b}). In 1989, 56.4% of the manufacturing jobs were located within a EPZ, in contrast with just 43.6% of the jobs located in companies outside of the zones (Kaplinksy, 1993).

According to the National Export Processing Zone Council's Statistical Report, in 2015, the Dominican Republic had 65 export processing zones operating, composed of 630 companies, generating 161,257 direct jobs and exports worth 5.5123 billion dollars, ranging across 1,724 sectors or products and going to 128 countries. Looking at export growth, between 2004 and 2008, the average export growth rate of the economic zones in Vietnam, Ghana, Bangladesh, and Honduras was 35, 31, 16, and 6%, respectively (^{Farole, 2011a}). Several other cases with a similar impact on jobs and exports can be found in Mauricio, South Korea, Taiwan, El Salvador, and Madagascar (^{Farole, 2011b}).

These data underscore the opportunities that the zone states in Mexico could enjoy in terms of increasing their share in national exports. In 2014 alone, the value of exports in the states of Chiapas, Guerrero, Michoacán, Oaxaca, and Veracruz, as a percentage of total national export value, fell toward the bottom of the country ranking, at just 0.4, 0.1, 0.3, 0.3, and 1.8%, respectively, of a total 397, 128, 659 million dollars (^{Centro de Estudios de las Finanzas Públicas, 2016}).

As a consequence of the first two static economic outcomes, the empirical evidence suggests that establishing economic zones has a direct impact on economic growth in the regions where they are set up, which is one of the main objectives described for this program in Mexico. The result has also been found in the case of China, one of the economies with the highest growth rates over the past decade. ^{Jones, Li, and Owen (2003)}, using city-level data on FDI -infrastructure, income, and government spending- found that the discrepancies in growth rates among cities with SEZ status are much higher than what has been found in previous studies using province-level data.

In their research, ^{Jones, Li, and Owen (2003)} estimated growth equations and ascertained that the policy to establish SEZs considerably improves economic growth, driving up annual growth rates by 5.5%; accordingly, the annual growth rate in coastal cities with an open economy turned out, on average, to be 3% higher than in the rest of the cities that did not have this status.

The zone states in Mexico could entail a good opportunity to counteract their low growth and weak contribution to the domestic economy. In 2014, the states of Chiapas, Guerrero, Michoacán, Oaxaca, and Veracruz had a share in the national economy, as a percentage of national Gross Domestic Product (GDP), of 1.8, 1.5, 2.4, 1.6, and 5%, respectively, of a total of 13,401,020 million pesos. Contrast that with the shares enjoyed by Mexico City, State of Mexico, and Nuevo León, which contribute the most to the national economy, with shares representing 16.8, 9, and 7-5% of national GDP, respectively (^{Centro de Estudios de las Finanzas Públicas, 2016}).

Finally, an additional static outcome of FDI in economic zones is tied to the positive externalities they generate for neighboring regions. Analyzing the concentration of FDI in the different regions throughout China in the time period 1996-2004, ^{Ouyang and Fu (2012)} found that the positive interregional externalities of coastal FDI (where the SEZs are located) are significant, robust, and economically important: an increase of one standard deviation in coastal FDI raises the growth rate of the inland cities by 33% on average.

Without these secondary interregional effects derived from FDI, ^{Ouyang and Fu (2012)} assert that the regions inland would not have grown as fast as they did. These findings lead them to suggest that interactions within supply chains across inland companies and foreign coastal companies are an important channel through which inland regions benefit from the positive interregional externalities of coastal FDI. In the case of Mexico, these effects are a good opportunity for economic growth in the states, regions, and municipalities that are directly impacted by the SEZs, by integrating them into the local economy via productive chains and local clusters that spring up.

In brief, in the short term, SEZ policies have a direct impact on growth by creating an environment more conducive to production and, indirectly, by attracting FDI to these cities (^{Jones et al., 2003}). Accordingly, the international evidence pertaining to the static outcomes points to positive prospects with respect to the aims outlined in Article 1 of the LFZEE.

Dynamic Economic Outcomes

Analysis of SEZ dynamics around the world has shown that it is an industrial policy whose most significant impacts are felt in the medium and long run. The cases of China, Malaysia, and the Philippines, success stories when it comes to implementing economic zones, took five to ten years before the most profound policy impacts became palpable.

In order for the economic zone model to be successful in the long term, it must contribute to structurally transforming the local economy through its multiplicative effects, among which are the following: productive diversification, trade liberalization, transfer of hard and soft technology among the local economy, and investors in the zone. Likewise, there ought to be an endeavor to develop management skills and train human capital; the creation of industrial clusters and integration of regional value chains; support from public and private institutions (both sectoral and cross-cutting); and a guarantee that the labor market can facilitate the mobility of skilled labor among companies, all of which are changes that will require effective public policies (^{Bräutigam & Tang, 2014}; ^{Farole, 2011b}; ^{Ortega, Acielo & Hermida, 2015}).

From 1978 to 2008, the economic zone model in China generated a significant economy of agglomeration by boosting technological progress in the municipalities with these zones by 1.6% as compared to those who carried out a program later, an effect that gradually built up in the wake of the economic zone program (^{Wang, 2013}). Trade liberalization policies via SEZs went hand in hand with the implementation of a variation on the Economic and Technology Development Zones (ETDZ) up and down the coast and throughout the inland areas of the country, focusing less on basic industries and more on technology-intensive industries. As of 2010, there were 69 ETDZs throughout the country. Additionally, other types of SEZs were set up, including high-tech development zones, free zones, export processing zones, and more, each with a different approach (^{Zeng, 2010}).

Nor did knowledge and technology transfer, as well as diversification into more complex goods in the economic zones, manage to make productivity levels budge. Using data from 29 manufacturing industries located in the Chinese city of Shenzhen in the time period 1993-1998, ^{Liu (2002)} found a significant and positive relationship between FDI in the manufacturing industry and productivity and the productivity growth rate of its component industries, suggesting that FDI generates externalities in the form of technology transfer. Specific estimates of the effect of FDI on productivity point to a situation in which an increase of 1% in the average level of FDI in the manufacturing industry can boost the productivity growth rate among component industries by up to 5%. This FDI is attracted to less developed countries in large part thanks to special incentives that local governments offer to foreign companies, primarily in the form of tax incentives and infrastructure subsidies.¹²

The EPZs in the Dominican Republic went through the opposite experience, where, despite their success in terms of employment and short-term static economic outcomes, it became clear that structural change in the local economy would be essential to the ultimate socioeconomic results. Although trade preferences and tax incentives are hallmarks of economic zones, not to mention low labor costs in developing countries, and can serve as catalysts for the model, they are almost never sustainable. EPZs are frequently wielded as a policy to drive exports in less developed countries, the majority of whose comparative advantages reside in producing items intensive in untrained labor. Generally speaking, the companies set up in these zones not only enjoy tax benefits, but also capitalize on the labor and public services the domestic economy provides.

In the Dominican Republic, the EPZ program was launched in 1969 in what was called the La Romana zone. By 1991, there were 22 zones up and running, six under construction, and seven undergoing review. The incentives offered to the companies included the following: import all inputs tax-free and without restriction; total liberty from foreign exchange constrains; complete exemption from all taxes and fiscal levies for 15-20 years; unrestricted repatriation of earnings; and no financial reporting requirements with the exception of local procurement (Kaplinksy, 1993). Nevertheless, the weight of manufacturing labor used in EPZs at the end of the nineteen-eighties fell largely in low-added-value activities, like making clothing and shoes, which not only ramps up the competition between less-developed countries with a policy of this sort in place, but also is unlikely to generate any true economic development.

Based on the study, Kaplinksy posited a viable alternative as not only manufacturing products in which the main comparative advantage is unskilled labor, but also requiring various forms of skilled labor, in an attempt to capture a piece of the pie of income stemming from existing skilled sub-processes. Even so, achieving these objectives requires making adjustments on various fronts, including expanding education and training, and reorienting the financial markets.

Dynamic economic outcomes constitute the most significant challenge facing the SEZ model in Mexico. Implementing them in the short and medium term requires truly structurally transforming the entities that permit these outcomes to remain sustainable in the long term. As one of the earlies studies looking at SEZs in Mexico found, ^{Gómez-Zaldívar (2017)} identified that the zone states are among the least complex in terms of their productive structure, read, those with low productive diversification specialized in economic activities and industries that the rest of the states also have. The significance of this analysist, and what follows from it, is that the current economic structure of the regions determines in large measure their potential for diversification and productive sophistication. Accordingly, the decision as to what type of industry to develop in each zone in turn entails designing specific policies, even for the industries themselves, depending on the productive capabilities existing in each region.

Socioeconomic Outcomes

The primary aim of attracting investment, both local and foreign, to economic zones is to directly and indirectly create jobs. Like many location-based models, economic zones seek to foster economies of agglomeration by promoting interaction among companies, raising productivity via the construction of conglomerates, or attracting technologically advanced industrial facilities (^{Combes et al., 2011}). Finally, success in attaining static and dynamic economic outcomes in the zones will help achieve desired socioeconomic outcomes with respect to raising the quality of employment and ensuring decent wages for the local population.

When it comes to wages, in China, based on estimates using the Differences in Differences model, ^{Wang (2013)} concluded that the average wage earned by treatment groups in the study was approximately 8% higher than in the control group, and that only a 5% increase in cost of living was estimated. Accordingly, wage increases for the workers outpaced the rising local cost-of-living; the benefits were smaller in more recently-created zones, and municipalities with multiple SEZs experienced greater effects than those with just one zone.

Looking at Africa, besides Mauritius, Madagascar is the only success story of an EPZ policy, despite myriad attempts to create economic zones throughout this part of the continent. Beginning with the implementation of this model in the early nineteen-nineties, the Madagascar free zone gained considerable ground in just one decade where exports and formal employment are concerned (^{Cling et al., 2005}). By estimating Mincer earnings functions considering data on gender, years of schooling, experience, and a dummy variable to estimate the earnings premium associated with the zone, the study concluded that paid remuneration in the zone is not different, everything else being constant, than those paid by other industries in the formal private sector, a fairly accepted fact for free zones in general. Nevertheless, these authors found that companies in the zone did have on average higher salaries than the informal sector and better labor conditions than the rest of the private enterprises, which can be seen as a good point of departure for the zones to develop in Mexico.

The case in Bangladesh is less heartening. According to the World Bank, although EPZs have played an important role in supporting the rapid growth of exports in the apparel sector, the most critical factor underlying this growth was the country's advantage in labor costs. Low-skilled apparel factory workers in Bangladesh -pre-2010- earned the lowest paid wages in formal employment in any part of the world, with starting salaries at around 30 dollars a month, 2.5 times lower than the next-cheapest country (Vietnam), and three times less than the majority of African SEZs (^{Farole and Akinci, 2011}).

On this point, the states where SEZs will be developed in Mexico enjoy a significant opportunity. In 2014 alone, the residents of Chiapas, Guerrero, Michoacán, Oaxaca, and Veracruz were earning below the national quarterly average income (39,914 pesos); salaries were lowest in Chiapas, with average current income at just 22,603 pesos, followed by Oaxaca, Guerrero, Veracruz, and Michoacán, with 24,041, 25,635, 28,029, and 29,846, respectively (^{Centro de Estudios de las Finanzas Públicas, 2016}).

Finally, another major socioeconomic outcome resulting from implementing these economic zones around the world, which itself deserves a detailed study, is improved gender equity in workforce participation. In 2006, workforce participation in SEZs in Bangladesh, Mexico, the Philippines, the Dominican Republic, and South Korea was 85, 60, 74, 53, and 70%, respectively (^{Farole and Akinci, 2011}).