Economic Zones

How Special Economic Zones are Financed

In order to provide a successful and relatively stable environment, the models used to finance SEZ projects have diverged. This gives the three broad models of SEZ financing: Government, Public-Private Partnerships, and Private.
,  
June 1, 2022
June 1, 2022

Introduction to the basic models

In order to provide a successful and relatively stable environment, the models used to finance SEZ projects have diverged. This gives the three broad models of SEZ financing: Government, Public-Private Partnerships, and Private.

Since proving successful and relatively stable, depending on the host country, the models used to finance SEZ projects have diverged. Governments have entered into several different types of agreements with private enterprise, in what are known as public-private partnerships. These cover everything up to the private party requesting land be designated as an SEZ, developing the infrastructure, and operating the zone for profit at completion, with the government simply taking an equity stake in the zone. The responsibilities can be divided with the government depending on the particular agreement.

In the case of PPPs it is common for a new company to be established with both the public and the private partners being shareholders and board members.¹ 

Finally, private firms are now taking on the total responsibility, a situation that has become more common in recent decades. Even in zones designated as private it is still common for the government to have some form of involvement, ownership, or oversight.

This gives the three broad models of SEZ financing: Government, Private Public Partnership, and Private.

There are always added layers of complexity when discussing SEZs as there is no single format for the physical infrastructure or the legal structure. A zone can range from a single tenant, like the Mexican Maquiladoras², to an entire city with residential and leisure space, like Iskandar in Malaysia³, resulting in the investment requirements differing enormously.

The scope of what a zone provides to tenants also varies. Zones might only be a flattened area and a perimeter boundary, leaving all other internal work to the tenants. At the other end of the scale there are zones that provide all physical infrastructure within the zone as well as support programs, such as counsel to facilitate interaction with customs and other government agents.

Nevertheless the three basic models apply and so we will look at the role of government and private business in the financing process.

Government's role in financing 

The benefits available to tenants usually include tax benefits, these can be taken as an opportunity cost meaning that the government is always a key player to understand even when they are not involved in the development of zone infrastructure. 

Another common expense for governments is external infrastructure such as roads and utilities. There are cases, such as Gabon, where the private company involved in a partnership with the government to build the zone also supported the country’s wider infrastructure development in order to increase the efficacy of the zone. 

However, it is more common for the agreement to include commitment from the government to provide for the external infrastructure such as in Kigali, Rwanda. Here the government was able to raise money through selling bonds and also through international development organizations and foreign governments⁴ which they put towards the Kigali Free Zone as well as roads and utilities.

Government’s ability to secure large loans from development agencies, such as the African Development Bank⁵, and foreign governments has been vital in the development of SEZs in developing countries.

The private companies developing SEZs still often rely on the government to provide external infrastructure and access to utilities, such as in India where several business parks were built in the National Capital Region (NCR) of New Delhi and proved very successful once a new highway was completed increasing the ease of access to the area.

Government motivation in financing 

Governments are often motivated by different objectives than private enterprise. They are more willing to focus on less quantifiable objectives than the classical profit making motive.

Government aims can include FDI attraction, knowledge sharing, area regeneration, and other goals, alongside the economic objectives.

This has resulted in many unproductive zones where the focus on the wider goals distracted from the need for the zone to be economically viable. For example governments have on several occasions established zones in underproductive regions of the country without good access to logistics networks or consistent utilities.

Another use for SEZs to governments is as a test bed of new policy. A country with a failing regulatory state, or powerful lobbying forces, can implement reforms in a limited area and prove they can work. Once this has been done the reforms are then easier to implement in the wider setting of the whole country.

Private enterprise's role in financing 

When the modern incarnation of Special Economic Zones began they were typically funded by the government. 

India opened its first SEZ in 1965 in Kandla as an export processing zone. It wasn’t until 2006, after India formalised and improved their SEZ policy in the 2005 SEZ Act⁶, that private companies began to play a bigger role in the financing and development of SEZs. This trend is replicated across the world, with the proportion of private SEZs beginning to increase from around the year 2000.⁷ 

Private financing can be in the form of developing the zone itself, building the internal infrastructure, or the requirement to invest a certain amount up front to secure a place in the zone. Zone development is still typically only taken on by major real estate developers.

An interesting model has developed whereby a private entity that successfully builds and operates a zone then establishes a franchise model and goes on to develop several more zones. An example of this is Grupo ZFB, the largest zone operator in Colombia.⁸ 

Private enterprise’s motivation in financing 

The primary motivation for private investment into SEZs is the profit making motive. Companies that identify favourable business conditions see value in the investment.

It is becoming clear that attracting this investment requires more than simple tax breaks. Companies are looking for strategic advantages along their GSV’s.

One way of achieving this is targeting a zone at a specific industry cluster in an attempt to create a high performing hub. An example of this is the Nkok SEZ in Gabon which has targeted companies all along the timber value chain. These efforts were supported by the government which banned the exports of unhewn logs to drive up the value to businesses of locating within Gabon.⁹

An example of a non-financial benefit attracting a company is Volkswagen in Rwanda. The company was given the right to test self-driving cars. This combined with their projections of the increase in demand for mobility in East Africa settled their investment decision. The company now operates a full mobility service from ride sharing to car hire throughout Kigali, proving to be an important test bed for their new system.¹⁰ 

Conclusion

Special Economic Zones require high levels of capital to complete. This capital comes from the host country's government, private enterprise, international development institutions, and foreign governments. 

When the concept was in its infancy the risk was typically taken on by governments who could place more confidence in the continuity of policy regarding the created zones.

As zones continued to develop and policy stabilized, the benefits became clearer to private entities, resulting in an increase in private zones since the year 2000. 

There is no universal model for the financing of a zone as it depends heavily on the type, size, ownership, and other factors. As the scope and potential of zones continues to adapt it is likely we will see further additions to the financing models of SEZs.

References:

1. Financing Special Economic Zones; Supporting Economic Transformation

SET_Financing-Models-for-SEZs_Final.pdf (odi.org)

2. What is maquiladora in Mexico - the history and success story; Manufacturing In Mexico.org

https://manufacturinginmexico.org/maquiladora-in-mexico/

3. Iskandar Malaysia; Iskandar Malaysia  

http://iskandarmalaysia.com.my/

4.Rwanda signs $300 million in loan deals with China and India; Reuters

https://www.reuters.com/article/us-rwanda-china-idUSKBN1KE0TQ

5. Funding And Financing Free And Economic Zones In Africa And The Role Of The African Development Bank; African Development Bank

https://www.africaeconomiczones.com/wp-content/uploads/2019/02/Funding-and-Financing-Free-Economic-Zones-AFZO-2018.pdf

6. Special Economic Zones Act, 2005; Legal Service India

http://www.legalservicesindia.com/article/430/special-Economic-Zones-Act,-2005.html

7. Financing Special Economic Zones: Different Models Of Financing And Public Policy Support; Support Economic Transformation

https://set.odi.org/wp-content/uploads/2018/09/SET_Financing-Models-for-SEZs_Final.pdf

8. Profit Machines: Exploring The Financing Of Colombian SEZs; Adrianople Group

https://www.adrianoplegroup.com/post/profit-machines-exploring-the-financing-of-colombian-sezs

9. Gabon Bans Log Exports; Mongabay

https://news.mongabay.com/2010/06/gabon-bans-log-exports/ 

10. First for Africa: Volkswagen and Siemens launch joint electric mobility pilot project in Rwanda; Volkswagen Newsroom

https://www.volkswagen-newsroom.com/en/press-releases/first-for-africa-volkswagen-and-siemens-launch-joint-electric-mobility-pilot-project-in-rwanda-5510

Tags
Economic Zones

How Special Economic Zones are Financed

In order to provide a successful and relatively stable environment, the models used to finance SEZ projects have diverged. This gives the three broad models of SEZ financing: Government, Public-Private Partnerships, and Private.
,  
June 1, 2022
June 1, 2022

Introduction to the basic models

In order to provide a successful and relatively stable environment, the models used to finance SEZ projects have diverged. This gives the three broad models of SEZ financing: Government, Public-Private Partnerships, and Private.

Since proving successful and relatively stable, depending on the host country, the models used to finance SEZ projects have diverged. Governments have entered into several different types of agreements with private enterprise, in what are known as public-private partnerships. These cover everything up to the private party requesting land be designated as an SEZ, developing the infrastructure, and operating the zone for profit at completion, with the government simply taking an equity stake in the zone. The responsibilities can be divided with the government depending on the particular agreement.

In the case of PPPs it is common for a new company to be established with both the public and the private partners being shareholders and board members.¹ 

Finally, private firms are now taking on the total responsibility, a situation that has become more common in recent decades. Even in zones designated as private it is still common for the government to have some form of involvement, ownership, or oversight.

This gives the three broad models of SEZ financing: Government, Private Public Partnership, and Private.

There are always added layers of complexity when discussing SEZs as there is no single format for the physical infrastructure or the legal structure. A zone can range from a single tenant, like the Mexican Maquiladoras², to an entire city with residential and leisure space, like Iskandar in Malaysia³, resulting in the investment requirements differing enormously.

The scope of what a zone provides to tenants also varies. Zones might only be a flattened area and a perimeter boundary, leaving all other internal work to the tenants. At the other end of the scale there are zones that provide all physical infrastructure within the zone as well as support programs, such as counsel to facilitate interaction with customs and other government agents.

Nevertheless the three basic models apply and so we will look at the role of government and private business in the financing process.

Government's role in financing 

The benefits available to tenants usually include tax benefits, these can be taken as an opportunity cost meaning that the government is always a key player to understand even when they are not involved in the development of zone infrastructure. 

Another common expense for governments is external infrastructure such as roads and utilities. There are cases, such as Gabon, where the private company involved in a partnership with the government to build the zone also supported the country’s wider infrastructure development in order to increase the efficacy of the zone. 

However, it is more common for the agreement to include commitment from the government to provide for the external infrastructure such as in Kigali, Rwanda. Here the government was able to raise money through selling bonds and also through international development organizations and foreign governments⁴ which they put towards the Kigali Free Zone as well as roads and utilities.

Government’s ability to secure large loans from development agencies, such as the African Development Bank⁵, and foreign governments has been vital in the development of SEZs in developing countries.

The private companies developing SEZs still often rely on the government to provide external infrastructure and access to utilities, such as in India where several business parks were built in the National Capital Region (NCR) of New Delhi and proved very successful once a new highway was completed increasing the ease of access to the area.

Government motivation in financing 

Governments are often motivated by different objectives than private enterprise. They are more willing to focus on less quantifiable objectives than the classical profit making motive.

Government aims can include FDI attraction, knowledge sharing, area regeneration, and other goals, alongside the economic objectives.

This has resulted in many unproductive zones where the focus on the wider goals distracted from the need for the zone to be economically viable. For example governments have on several occasions established zones in underproductive regions of the country without good access to logistics networks or consistent utilities.

Another use for SEZs to governments is as a test bed of new policy. A country with a failing regulatory state, or powerful lobbying forces, can implement reforms in a limited area and prove they can work. Once this has been done the reforms are then easier to implement in the wider setting of the whole country.

Private enterprise's role in financing 

When the modern incarnation of Special Economic Zones began they were typically funded by the government. 

India opened its first SEZ in 1965 in Kandla as an export processing zone. It wasn’t until 2006, after India formalised and improved their SEZ policy in the 2005 SEZ Act⁶, that private companies began to play a bigger role in the financing and development of SEZs. This trend is replicated across the world, with the proportion of private SEZs beginning to increase from around the year 2000.⁷ 

Private financing can be in the form of developing the zone itself, building the internal infrastructure, or the requirement to invest a certain amount up front to secure a place in the zone. Zone development is still typically only taken on by major real estate developers.

An interesting model has developed whereby a private entity that successfully builds and operates a zone then establishes a franchise model and goes on to develop several more zones. An example of this is Grupo ZFB, the largest zone operator in Colombia.⁸ 

Private enterprise’s motivation in financing 

The primary motivation for private investment into SEZs is the profit making motive. Companies that identify favourable business conditions see value in the investment.

It is becoming clear that attracting this investment requires more than simple tax breaks. Companies are looking for strategic advantages along their GSV’s.

One way of achieving this is targeting a zone at a specific industry cluster in an attempt to create a high performing hub. An example of this is the Nkok SEZ in Gabon which has targeted companies all along the timber value chain. These efforts were supported by the government which banned the exports of unhewn logs to drive up the value to businesses of locating within Gabon.⁹

An example of a non-financial benefit attracting a company is Volkswagen in Rwanda. The company was given the right to test self-driving cars. This combined with their projections of the increase in demand for mobility in East Africa settled their investment decision. The company now operates a full mobility service from ride sharing to car hire throughout Kigali, proving to be an important test bed for their new system.¹⁰ 

Conclusion

Special Economic Zones require high levels of capital to complete. This capital comes from the host country's government, private enterprise, international development institutions, and foreign governments. 

When the concept was in its infancy the risk was typically taken on by governments who could place more confidence in the continuity of policy regarding the created zones.

As zones continued to develop and policy stabilized, the benefits became clearer to private entities, resulting in an increase in private zones since the year 2000. 

There is no universal model for the financing of a zone as it depends heavily on the type, size, ownership, and other factors. As the scope and potential of zones continues to adapt it is likely we will see further additions to the financing models of SEZs.

References:

1. Financing Special Economic Zones; Supporting Economic Transformation

SET_Financing-Models-for-SEZs_Final.pdf (odi.org)

2. What is maquiladora in Mexico - the history and success story; Manufacturing In Mexico.org

https://manufacturinginmexico.org/maquiladora-in-mexico/

3. Iskandar Malaysia; Iskandar Malaysia  

http://iskandarmalaysia.com.my/

4.Rwanda signs $300 million in loan deals with China and India; Reuters

https://www.reuters.com/article/us-rwanda-china-idUSKBN1KE0TQ

5. Funding And Financing Free And Economic Zones In Africa And The Role Of The African Development Bank; African Development Bank

https://www.africaeconomiczones.com/wp-content/uploads/2019/02/Funding-and-Financing-Free-Economic-Zones-AFZO-2018.pdf

6. Special Economic Zones Act, 2005; Legal Service India

http://www.legalservicesindia.com/article/430/special-Economic-Zones-Act,-2005.html

7. Financing Special Economic Zones: Different Models Of Financing And Public Policy Support; Support Economic Transformation

https://set.odi.org/wp-content/uploads/2018/09/SET_Financing-Models-for-SEZs_Final.pdf

8. Profit Machines: Exploring The Financing Of Colombian SEZs; Adrianople Group

https://www.adrianoplegroup.com/post/profit-machines-exploring-the-financing-of-colombian-sezs

9. Gabon Bans Log Exports; Mongabay

https://news.mongabay.com/2010/06/gabon-bans-log-exports/ 

10. First for Africa: Volkswagen and Siemens launch joint electric mobility pilot project in Rwanda; Volkswagen Newsroom

https://www.volkswagen-newsroom.com/en/press-releases/first-for-africa-volkswagen-and-siemens-launch-joint-electric-mobility-pilot-project-in-rwanda-5510

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