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«August 1999 Dorsati Madani Address: PREM- EP The World Bank EM: dmadani CONTENTS: Acknowledgments Disclaimer List of Abbreviations ...»

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A Review of the Role and Impact of

Export Processing Zones

August 1999

Dorsati Madani



The World Bank

EM: dmadani@worldbank.org




List of Abbreviations

Executive Summary

I. Introduction and Definition

A. Definition:

A1. What are EZPs

A2. Characteristics and goals

A3. Why do countries use EPZ and EPF schemes?

II. The Economic arguments for and against EPZs.

A. Foreign exchange earning potential B. Tax revenue/tax loss effects C. FDI: catalyst effects D. FDI: technology transfer, knowledge spillover and backward linkages E. Employment effect on local/national economy F. Women and EPZ employment G. Education/training benefits (human capital development) H. Wages, labor and safety laws I. Environmental issues J. EPZs and the economic and policy environments III. EPZs, Globalization, Regional Integration Agreements and WTO A. EPZs in the context of regional integration/trade arrangements B. The Uruguay Round, export subsidies and EPZs IV. The administrative and regulatory environment A. Open or closed production area?

B. Location and infrastructure C. Government involvement and institutional needs D. Geographical position of the country and access to international markets E. Summary of practical lessons for a successful zone V. The actual experience: two African cases A. Mauritius B. Senegal VI. Policy Suggestions Annex A: Brief review of theories regarding EPZs Annex B: Brief notes on some African EPZs.

A. Togo B. Namibia C. Kenya D. Cameroon E. Zimbabwe References

List of Tables:

Table 1: Incentives and provisions offered in EPZs in the Caribbeans and Central America Table 2: Incentives and provisions offered in EPZs in select Sub-Saharan African countries Table 3: Impact of EPZs in select Sub-Saharan African countries Table 4: Impact of EPZs in select countries Table 5a: Industrial concentration of select zones Table 5b: Industrial Concentration of select zones based on percentage of workforce involved in main products lines or provisions of main exports.

Table 6: Employment creation in select EPZs Table 7: Central America: Minimum Wage in EPZs and National Minimum (in US dollars), 1995.

Acknowledgment The author wishes to extend special thanks to A. L. Winters for his suggestions and assistance throughout the development and completion of this document. The author also thanks W.

Martin, J. Emery, J.Alvarez, R. Smith, M. Schiff, D. Keesing, P. Blay, J. Hanna, T. Kusago, C.

Barham, T. Akiyama, F. Bakoup, N. van Gelder, A. Grudzinska, C. Azi, S. Gray, M.

Dorfman, G. Byam, R. Blake, E. Scanteie and G. Pursell, for their contributions during the research and writing of this paper. The author also acknowledges and appreciates comments and suggestions made during the presentation of this paper at the World Bank DEC/RG in February 1998. All remaining errors are those of the author.


The findings, interpretations, and conclusions expressed in this paper are entirely those of the author. They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. The paper should not be quoted or cited without the permission of the author.

Acronyms and Abbreviations:

EPZ: Export Processing Zone EPF: Export Processing Firm WTO: World Trade Organization RIA: Regional Integration Agreement RTA: Regional Trade Agreement EU: European Union NAFTA: North-American Free Trade Area OECD: Organization for Economic Cooperation and Development CBI: Caribbean Basin Initiative

–  –  –

I. Introduction, Definition, characteristics and goals:

Export processing zones (EPZs) have become rather popular trade policy instruments since their modern revival in the late 1950s. While in 1970 only a handful of countries permitted a zone, a recent OECD publication (1996), places the total number of zones at 500 located in 73 countries

• We define export processing zones as fenced-in industrial estates specializing in manufacturing for exports that offer firms free trade conditions and a liberal regulatory environment (World Bank, 1992:7). We allow for some domestic sales and include export processing firms (EPFs)- which benefit from the same EPZ incentives without being fenced in in our analysis.

• The primary goals of an export processing zone are:

1. To provide foreign exchange earnings by promoting non-traditional exports.

2. To provide jobs to alleviate unemployment or under-employment problems in the country and assist in income creation.

3. To attract foreign direct investment (FDI) and engender technological transfer, knowledge spill-over and demonstration effects that would act as catalysts for domestic entrepreneurs to engage in production of non-traditional products.

• Zones share a few common features:

1. Unlimited, duty-free imports of raw, intermediate input and capital goods necessary for the production of exports.

2. Less governmental red-tape. More flexibility with labor laws for the firms in the zone than in the domestic market.

3. Generous and long-term tax holidays and concessions to the firms.

4. Above average (compared to the rest of the host country) communications services and infrastructure. It is also common to for countries to subsidize utilities and rental rates.

5. Zone firms can be domestic, international or joint venture. The role of FDI is prominent in EPZ activities.

Zones can be categorized into public or private zones (owned or managed), and highend or low-end. The latter distinction refers to the range of quality of management, facilities and services provided by the zone and therefore, the type of firms populating it.

II. A broad brush picture of EPZ experiences:

• Under propitious circumstances and good management, EPZs generally achieve the two basic goals of creating employment (especially non-traditional employment and income opportunities for women) and increasing foreign earnings. For instance, Mauritius EPZs boasted 71 percent of the nation’s gross exports in 1994 and employed 16.6 percent of the work force.

However, some argue that the net foreign earnings may not constitute a large enough sum to warrant the investments undertaken by the country to accommodate a zone. The opportunity costs of such public investments should be considered more closely. Furthermore, there are potential revenue losses from concessions on income taxes and tariffs.

• EPZs are sensitive to the national economic environment. They will perform better when the country pursues sound macroeconomic and realistic exchange rate policies (Romer, 1993; Alter, 1991).

• Zones may contribute to the building of national human capital in two ways.

Previously unskilled workers have benefited from EPZ presence. Their productivity has increased via job training and learning by doing. The benefits of this skill acquisition is limited however, as most production processes are low-skill and low-tech. The most valuable aspect of this type of employment, aside from the income earned, may be the workers’ learning of industrial work discipline and routine.

• Training has also occurred at the supervisory and managerial level, with local employees becoming privy to new organizational and managerial methods, negotiation and marketing skills, general business know-how, foreign contacts and entrepreneurship.

• In addition, a successful zone, per se, is an efficient and competitive industrial infrastructure. As such it provide the country in which it operates an industrial set-up which it may lacks. Most African nations would fit this profile.

• There are many cases of catalyst and demonstration effects (Rhee, 1990, Rhee and Belot, 1992) on the host economy. These effects, together with the labor training, may be the zone’s lasting contributions to the country in which it operates.

• Creation of backward linkages seems largely conditional on the industrial base of the nation. In countries which did not already enjoy a solid industrial base and which adopted EPZs to encourage these linkages and foster a domestic industrial base, some linkage occurred, though it was spotty and inconsistent, with firm zones complaining of the poor quality or the incompatibility of local inputs.

• In countries where a solid industrial base existed prior to the establishment of the EPZs -e.g. Taiwan and S. Korea- linkages have occurred. The transfer of know-how and technology was facilitated by the existing technological sophistication and highly educated labor force. In these cases, EPZs were only one tool in a panoply of governmental policies to foster economic growth through export promotion. Even at the height of their influence, EPZs never acquired a prominent role either in terms of exports value or employment creation in S. Korea or Taiwan.

• Wages in most EPZs are equal or higher than average wages outside the zones.

However, there a noted variance around this average. Lax labor, work safety and health laws in many zones have raised concerns with regards to workers’ welfare. The size, nationality and corporate policy of the firm, the type of industrial production, labor market conditions and the country’s institutions and regulations play a determining role in establishing the wage rate, workers’ rights and work environment in EPZs.

• The environmental impact of zone production and lax government regulation and monitoring has also raised some concern. There is some information confirming environmental pollution, however, we lack systematic qualitative and quantitative analysis on the topic that would lead to well targeted, sensible regulation and monitoring.

• Some consider a successful zone a good model for country policy makers to mimic in formulating liberalizing domestic policies. In this case EPZs facilitate liberalization efforts.

Others argue that a successful zone may be used as a safety valve, providing jobs and foreign exchange earnings, and thus easing the pressure on policy makers to undertake economy wide reforms. Zones would then be a stumbling block to liberalization. A third and more recent development is that of post -macro and trade- reform economies (such as Uganda) considering or establishing zones (among other export promotion tools) to bolster low FDI inflows.

• Overall, the EPZs did not universally fulfill the role of “engines of industrialization and growth” as some proponents had anticipated. They have been an engine --among others -- in the economy, when they have been given their proper place as a policy tool, and where proper perspective is taken as to the their ultimate achievements and costs. EPZs’ greatest contribution seems to be job creation and income generation. Their lasting legacy can be three fold. They can contribute to building human capital, and through their demonstration and catalyst effects on the country entrepreneur pool. Also, an efficient, competitive zone is an industrial infrastructure that many countries lack.

• EPZs face new challenges in the increasingly global economy. Rapid changes in consumption preferences and the resulting competitive pressures to meet this demand can affect the locational choices of investors. Furthermore, increased product sharing is changing the reducing the need for country specific technical expertise. This phenomenon has a differential impact on industries as a function of their technical sophistication.

• Exclusion of a country from a preferential trade/integration arrangement seems to impact EPZ firms and EPFs which operate there negatively (e.g. Impact of NAFTA on firms and EPZs in the Dominican Republic). These firms may or may not flourish from the membership of their host country in preferential trade arrangements. The EPZ firms’ (and EPFs) initial product mix, market orientation, technological sophistication, strategic business planning and adaptability to the new competitive conditions will have a material influence on their continued success and contributions to the country in which they operate.

• The compatibility of EPZ incentives with WTO rules is country specific. Many of the incentives offered to firms are considered export subsidies and developing countries may or may not qualify for a timed or extended exemption from them. Least developed countries and developing countries with less than $1000 per capita GNP are exempted from disciplines on prohibited export subsidies.

III. Policy recommendations.

A. General economic policy:

• An EPZ is not a first best policy choice. The best policy is one of overall liberalization of the economy. Furthermore, EPZs and EPFs are only two of may trade instruments used by firms and countries to promote export development and growth, and have limited applicability. Other policy tools may therefore be more appropriate for a specific country than an EPZ

• Nonetheless, zones can play a long term dynamic role in their country’s development process if they are appropriately set-up, well managed, WTO compatible in its incentives, and used as an integrated part of a national reform and liberalization program. At the very least they should not constitute stumbling blocks to the reform process by being used as “safety valves”.

In this manner, the host economy will benefit more fully from the zones potential contributions in terms of human capital and their demonstration and catalyst effects.

• Establishing an EPZ in a country that has undertaken trade and macroeconomic reform is not recommended on three grounds. First, the low FDI inflow may be due to inadequate legal or regulatory framework, or distorted economic incentives in other areas of the economy (e.g. private property laws). Second, EPZs are distortionary trade instruments and introduce an element of discretion into the policy environment. Finally, even if export promotion is in order (i.e. WTO compatible and deemed a solution to the country’s low FDI inflow), an EPZ may not be the best instrument to achieve such a goal.

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