The World Bank 21234 December PREMnotes 1998 number 11 Economic Policy Export processing zones Export processing zones are potentially useful tools for export promotion. To foster development, however, zones must be set up properly, managed well, and integrated with other reforms. Over the past three decades export pro- spillover, demonstration effects, and back- cessing zones have become popular instru- ward linkages. ments of trade policy, offering firms located Zones generally share several common in them free trade conditions and a lib- features: eral regulatory environment. In 1970 only • They allow duty-free imports of raw and a handful of countries permitted such zones, intermediate inputs and capital goods As export but by 1996 there were more than 500 zones for export production. in 73 countries (OECD 1996). This note • Government red tape is streamlined, processing zones outlines the general features and objectives allowing “one-stop shopping” for per- of these zones, highlights country experi- mits, investment applications, and the have become more ences with them, and offers policy recom- like. In addition, labor laws are often mendations for establishing them. more flexible than for most firms in the widespread, the domestic market. What is a zone? • Firms in zones are given generous, long- policies governing An export processing zone is one of many term tax concessions. export promotion tools, including bonded • Communications ser vices and infra- them have become warehouses and temporar y admission structure are more advanced than in schemes. Today’s export processing zones other parts of the country. Utility and more important have evolved from their original defini- rental subsidies are common. tion as “an industrial estate, usually a fenced- • Zone firms can be domestic, foreign, in area of 10–300 hectares, that specializes or joint ventures. Foreign direct invest- in manufacturing for export.” (World Bank ment plays a prominent role. 1992, p. 7). Many firms, called export pro- Two main features differentiate export cessing firms, now benefit from the incen- processing zones, however. First, zones can tives offered in the zones without being be publicly or privately owned or managed. physically fenced in. In addition, coun- Over the past 10–15 years the number of pri- tries have liberalized domestic sales—Mex- vately owned or managed zones has grown ico, for example, allows 20–40 percent of substantially because they are believed to its zones’ output to be sold domestically. achieve superior results. Second, zones can Export processing zones have three main be “high-end” or “low-end,” depending on goals. They are to provide a country with the quality of the management, facilities, and foreign exchange earnings by promoting services they provide firms. nontraditional exports. They are to create jobs and generate income. And they are Zone experiences to attract foreign direct investment, engen- Not all export processing zones have served dering technology transfer, knowledge as engines of industrialization and growth, f ro m t h e devel opm ent economics vice p resid enc y a nd pover t y re d u ct i o n a nd e co no mi c ma na ge me nt n e t w o r k as some proponents anticipated (Warr 1989, also occurs at the supervisory and managerial 1993; World Bank 1992). Zones have been levels, with local employees establishing for- engines—among others—in the economy eign contacts and learning new organiza- when they have been given their proper place tional and managerial methods, negotiation as a policy tool, and when their ultimate costs and marketing skills, general business know- and achievements are taken into account. how, and a spirit of entrepreneurship. Zones have been very successful in Mauritius, Catalyst and demonstration effects are also for example, but have failed in Senegal. common in the host economy (Rhee, Kat- Export processing zones are sensitive to terbach, and White 1990; Rhee and Belot the national economic environment and per- 1990), though backward linkages between Properly managed, form better when the host country pursues zones and domestic firms have not always sound macroeconomic and realistic exchange occurred. In general, some linkages have zones can generate rate policies. Properly managed, however, occurred in countries that did not already have zones can generate income and create jobs— a solid industrial base. But these linkages have income and especially nontraditional employment and been spotty and inconsistent, with some zone new employment opportunities for women firms complaining of the poor quality or create jobs (table 1). Their long-term contribution is incompatibility of local inputs. (Exceptions twofold. A competitive, efficient zone pro- include the Dominican Republic and Mau- vides an industrial infrastructure that many ritius.) Linkages have also occurred in countries lack. In addition, zones build economies—the Republic of Korea, Taiwan human capital directly and through their cat- (China)—that had a solid industrial base prior alyst and demonstration effects on host coun- to the establishment of the zones. In these try entrepreneurs. cases, however, export processing zones were Export processing zones build human cap- only one of the tools used to foster growth. ital in two ways. Previously unskilled work- Zones have increased gross foreign ers benefit from job training and learning by exchange earnings. In Mauritius zone export doing (Rhee, Katterbach, and White 1990). earnings jumped from 3 percent of gross These benefits are limited, however, because export earnings in 1971 to 67 percent in 1995. most production is low-skill and low-tech. Net foreign exchange earnings have not Still, workers earn income and learn indus- always lived up to expectations, however. In trial work discipline and routine. Training 1996 gross exports of three Jamaican zones Table 1 Employment creation and exports in selected export processing zones Region Year of Year Number Number Zone exports/ and economy first zone of data of workers of firms gross exports (percent) Africa Cameroon 1990 1995 2,567 16 32.5 Mauritius 1971 1995 80,466 481 67.0 Senegal 1974 1990 600 10 1.8 Asia Bangladesh 1983 1995–96 37,533 2 zones 11.1 Philippines 1972 1994 81,559 from 4 zones 11.0 1991 43,858 — 7.7 (1990) Sri Lanka 1979 1998 85,323 6 zones — 1990 60,000 — 23.0 Taiwan (China) 1966 1995 55,191 235 (3 zones) 5.6 Latin America and the Caribbean Costa Rica 1972 1996 24,000 191 21.0 El Salvador 1976 1991 6,500 14 14.5 Honduras 1976 1991 19,000 49 (9 zones) 12.0 Jamaica 1976 1996 16,804 56 (3 zones) 16.2 (2.0 of net exports) Source: World Bank data. totaled $235 million, but net exports were port credit insurance), an export processing just $29 million. Such earnings may not cover zone is a second-best policy choice. a country’s investment in a zone. Similarly, Zones can play a long-term dynamic role the opportunity cost of such investments may in their host country’s development if they not warrant the concessions granted (on are set up properly, managed well, and inte- income taxes and tariffs) to accommodate grated with a national reform and liberal- a zone. In fact, some zones may have a neg- ization program. At the very least they should ative net present value for the country. not become impediments to reform. Wages in most export processing zones For three reasons zones should not be are equal to or higher than average wages established in liberal, low-protection outside the zones, though there is consid- economies. First, lower than expected or Zones should erable variance around this mean. For unsatisfactory foreign direct investment instance, in Thailand in 1990 and Sri Lanka may be due to inadequate laws or regu- not be in 1992 wages in export processing zones lations, or to other distorted economic were higher than outside the zones. But in incentives (such as weak private property established in Mauritius in 1986 and Taiwan (China) in laws). Second, zones are distortionar y 1988 they were lower. And lax labor, safety, trade instruments and introduce an ele- liberal, low- and health laws in many zones have raised ment of discretion in the policy environ- concerns about workers’ welfare. ment. Finally, even if export promotion is protection The environmental impact of zones and appropriate (and compatible with World lax regulation and monitoring have also raised Trade Organization guidelines), an export economies concern. Environmental pollution has been processing zone may not be the best way confirmed in some zones (for example, in to achieve that goal. If post-reform eco- the Dominican Republic and Mexico). But nomies are intent on establishing new systematic analysis is lacking that would lead zones, differential fiscal incentives should to well-targeted, sensible regulation and mon- be minimized to reduce their distortionary itoring. Some observers argue that govern- impact on the host economy. ment attitudes toward worker and health conditions in and the environmental impact Policies for success of zones may not be much different from An export processing zone is more likely to prevalent national practices. Still, these are succeed when monetary and fiscal policies are important concerns. sound and stable, private property and invest- Some analysts consider a successful zone ment laws are clear, firms are free to repatri- a model for host country policymakers to ate earnings at market rates, and there are mimic in liberalizing the rest of the econ- no restrictions on foreign exchange. omy. Others argue that a successful zone Zone firms should be moderately taxed. may become a stumbling block for liberal- There is no need for overly generous tax ization by providing jobs and foreign incentives (permanent tax holidays, waiv- exchange earnings, and thus easing the pres- ing of all taxes). Indirect taxation and licens- sure on policymakers to undertake econo- ing should be rationalized and minimized, mywide reforms (as in India and Tunisia). and zones’ imports and exports should be Other countries (Uganda) have considered free of trade taxation and tariffs. or established zones after macroeconomic Utilities (water, electricity, sewage, and the and trade reforms to bolster foreign direct like) should not be subsidized; doing so dis- investment. courages economically rational use of resources and factors of production, undermining zones’ General recommendations benefits for host countries. Providing infra- In distorted economies an export processing structure outside the zone—telephony, roads, zone is one of a number of tools used to off- ports—can have positive spillovers for the local set anti-export bias. But just like other export and national economy by facilitating trans- promotion tools (bonded warehouses, ex- portation and communications. But onsite infrastructure—pavement, building shells— lic, considerable autonomy should be should be privately financed. granted (as in Taiwan, China). Business-friendly labor laws lower labor Zone firms exporting from one mem- costs. But strengthening regulations and ber of a trade arrangement should be aware monitoring can mitigate potential labor law of potentially complex rules of origin and infractions and improve working conditions, restrictions. reducing turnover and absenteeism and increasing worker productivity. Further reading An essential first step toward minimizing Madani, Dorsati. 1998. “A Review of the Role environmental impacts is to develop a qual- and Impact of Export Processing Zones.” Governments itative and quantitative understanding of World Bank, Development Research industrial refuse and its effects on air, soil, Group, Trade, Washington, D.C. should be fully water, and human health. Follow-up regu- OECD (Organisation for Economic Co-oper- lations, incentives, and monitoring should ation and Development). 1996. Trade, Employ- appraised of the be tailored accordingly. ment and Labour Standards: A Study of Core Zones in countries that are members of Workers’ Rights and International Trade. Paris. costs and benefits preferential trade arrangements (regional or Rhee, Yung Whee, and Therese Belot. 1990. bilateral) may be more attractive to firms Export Catalysts in Low-Income Countries: of the incentives targeting these markets, because such a mem- A Review of Eleven Success Stories. World bership enlarges potential market size and Bank Discussion Paper 72. Washington, they offer to export eases entry barriers (as in Mauritius). Exports D.C. from these zones may, however, face complex Rhee, Yung Whee, Katharina Katterbach, and processing zones rules of origin regulations and restrictions. Janette White. 1990. “Free Trade Zones in Export Strategies.” Industry Series Paper Administration, regulation, and 36. World Bank, Washington, D.C. incentives Warr, Peter G. 1989. “Export Processing Governments should be fully appraised of the Zones: The Economics of Enclave Man- costs and benefits—to the budget and to the ufacturing.” The World Bank Research country—of the incentives they offer to export Observer 4 (1): 65–88. processing zones. Incentives should be com- ———. 1993. “The Potential for Export Pro- patible with World Trade Organization rules cessing Zones: Lessons from East Asia.” and timelines on export promotion instru- Pacific Economic Bulletin 8 (1): 19–26. ments; otherwise host countries may face retal- World Bank. 1992. “Export Processing iatory actions by importing countries. In Zones.” Policy and Research Series Paper addition, zones and export processing firms 20. Industry and Energy Department, should be allowed to locate in various loca- Washington, D.C. tions (as in Mauritius). Government should provide efficient, This note was written by Dorsati Madani (Consult- streamlined, and prompt services for set- ant, International Trade, Development Research ting up and running export processing Group). zones (approval of investment applications, If you are interested in similar topics, consider customs and other super visor y institu- joining the Export Competitiveness Thematic Group. tions).Privately owned and managed zones Contact Garry Pursell, x38002, or click on Thematic should be encouraged. If zones are pub- Groups on PREMnet. This note series is intended to summarize good practice and key policy findings on PREM-related topics. PREMnotes are distributed widely to Bank staff and are also available on the PREM website (http://prem). If you are interested in writing a PREMnote, email your idea to Asieh Kehyari. For additional copies of this PREM- note please contact the PREM Advisory Service at 87736. Prepared for World Bank staff The original had problem with text extraction. pdftotext Unable to extract text.