0~~~~~~~~~~~~~~~~~~~~ Lu C]l a o~~~~~~~~~~~~~~~~~~~~~~ a Titles in the Policy and Research Series PRSI Adjustment Lending: An Evaluation of Ten Years of Experience Country Economics Department PRS2 Tax Policy in Sub-Saharan Africa: A Framework for Analysis Zmarak Shalizi and Lyn Squire PRS3 The Effects of Industrial Countries' Polices on Developing Countries J. Michael Finger and Patrick Messerlin PRS4 The Reform of State-Owned Enterprises: Lessons from World Bank Lending Mary Shirley PRS5 Trade Finance in Developing Countries Yung Whee Rhee PRS6 Seatrade, Logistics, and Transport I-lans Jurgen Peters PRS7 Competition Policies for Industrializing Countries Claudio R. Frischtak with Bita fHadjimichael and Ulrich Zachau PRS8 Soil Conservation in Developing Countries: Project and Policy Intervention Jock Anderson and Dodo Thampapillai PRS9 Industrial Restructuring: Policy and Practice Ira W. 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ISSN 1013-3429 Library of Congress Cataloging-in-Publication Data Export processing zones/Industry Development Division, Industry and Energy Department [and] Trade Policy Division, Country Economics Department. p. cm. - (Policy and research series, ISSN 1013-3429: 20) ISBN 0-8213-1988-4 1. Export processing zones - Developing countries. 2. Commercial policy. 1. International Bank for Reconstruction and Development. Industry and Energy Dept. Industry Development Division. II. International Bank for Reconstruction and Development. Country Economics Dept. Trade IPolicy Division. III. Series: Policy and research series: 20. HF1417.E95 1991 338.4'767-dc2O 91-45394 CIP Contents Foreword v Acknowledgment vi Abbreviations vii Executive summary 1 - Export processing zones and policy reform 6 Rational trade policies 6 Infrastructure and industrial estates 8 Foreign direct investment 9 2 W'orld Bank experience with export processing zones 10 Operational aspects 10 Policy aspects 11 3 Global experience with export processing zones 14 Benefits, costs, and performam:e indicators 14 Successes and failures around the world 14 4 Concerns about export processing zones 17 Employment effects and labor legislation 17 Impacts on economywide trade reforms 17 Discriminationand distortions 19 Tax incentives and foreign direct investment 19 Backward links 19 T'ransfer of technology and skills 20 Environmental effects 20 5 Lessons from experience and the role of the World Bank 21 C'ontributions and limitations of export processing zones 21 Factors influencing success or failure 22 Role of the World Bank 23 . . Appendix 24 Endnotes 38 References 42 Table 1 World Bank export processing zone (EPZ) projects, 1977-90 11 Boxes 1 Experience with operational aspects of export processing zones 12 2 Experience with policy aspects of export processing zones 13 Appendix tables A.1 Employment in export processing zones by region and economy, 1990 29 A.2 Value of exports from export processing zones by economy and individual zone, 1986-90 31 A.3 Employment and number of plants or firms in export processing zones, by region and economy 32 Appendix boxes A.1 Malaysia's experience with export processing zones 25 A.2 Experience of Taiwan (China) with export processing zones 26 A.3 Korea's experience with export processing zones 27 A.4 Sri Lanka's experience with export processing zones 28 iv Foreword The World Bank has long supported developing some recent EPZ successes based on private zone countries in reforming their inward-oriented development and operation have suggested the trade and regulatory policies to an outward- viability of innovative new approaches. oriented direction and in improving the interna- At the same time, many questions about the tional competitiveness of their industries. One relationship between the EPZ policy regime and of the key elements cri tical for theeffectiveimple- economywide policy reforms, as well as uncer- mentation of such reforms and improvements is tainty about the benefits and costs of EPZ indus- to design appropriate policy and administrative trial estate construction and EPZ links with the instruments that are suitable for the particular restof adevelopingeconomy,arebeingexpressed. conditions of a developing economy. To assist in Some concerns may stem partly fror the memory such design, the Industry Development Divi- of EPZ failures in the 1970s - related primarily to sion has carried out research and operational inappropriate location and to mistakes in indus- support work in export policy instruments and trial estate construction - and partly from the institutions. An export processing zone (EPZ) is increasing recognition of the imrrportance of one of the various export policy instruments economywide policy reformsin developingcoun- studied by the Division. tries in the 1980s and 1990s. In rPecent years, there has been growing inter- The purpose of this paper is to provide a per- est in EPZs, particularly among low-income de- spective on the EPZ as a policy instrument as well veloping countries, as a tool for helping them as an industrial estate, by reviewing global and the overcome their inability to generate an outward World Bank Group's experience with EPZs and supply response and to provide immediate em- highlighting conditions that have contributed to ploynnent, as well as foreign exchange earnings, their success and elements that have caused diffi- by inducing foreign direct investment. This also culties. reflects changing perceptions in developing This paper was prepared under the direction of couniries about the critical role of close collabo- the Industry and Energy Department by a team rationbetweenforeign anddomesticenterprises, consisting of members from the Industry Develop- beyond capital transfer alone, for initiating a ment Division of the Department a,nd the Trade low-income country's entry into the world mar- Policy Division of the Country Economics Depart- ket by taking advantage of the increasing inter- mentand has benefited fromextensiveconsultation natiornalizationof meanufacturingand trade. Also, and comments from the Country Departments. Anthony A. Churchill Director, Industry and Energy Department Sector and Operations Policy v Acknowledgments This report is based on a paper entitled "Export Processing Zones," dated June 8, 1991, containing contributions by a core team composed of Carl Dahlman, Katharina Katterbach, Donald Keesing, and Yung Whee Rhee, and with inputs, comments, and assistance from many others. vi Abbreviations EC - European Community EPZ - export processing zone FDI - foreign direct investment GATT - General Agreement on Tariffs and Trade IBRD - International Bank for Reconstruction and Developmen,t IFC - International Finance Corporation IME - International Monetary Fund OECD - Organization for Economic Cooperation and Development SAL - structural adjustment loan vii CP ExecUtive summary Export processing zones (EPZs) are one of several ment. The importance of the EPZ as a policy administrative instruments for providing free instrument tends to diminish as an economy be- trade status to manufactured exports. Along with comessuccessful in its outward-oriented strategy, a realistic exchange rate, sound macroeconomic though its value as an industrial estate may re- policies, ;nd liberalization and reform of import main. policies, making economywide duty-free systems Besides an appropriate policy regime, develop- work we]l for manufactured exports is a principal ing economies seeking to enter or expand manu- element of the trade policy reforms advocated by factured exports require adequate physical trade the World Bank Group since 1979. EPZs are found infrastructure and a legal and regulatory environ- mainly in developing economies, while the three ment favorable to private business and exporting. other cornmonly used systems - in-bond, duty- An EPZ, which is an industrial estate with rental exemption, and duty-drawback - which serve factory buildings, helps meet both requirements. different groups of exporters, are used widely in It specializes in manufacturing for export to more both developed and developing economies. Ex- advanced market economies by offering export- ports from EPZs in developing economies consti- ers duty-free imports, a favorable business envi- tuted 4 to 5 percent of these economies' total ronment, few regulatory restrictions, and a mini- manufactured exportsol $258billionin 1988. About mum of red tape. The EPZ thus combines two 80 percent of total EPZ exports came from three critical features: it is both an industrial estate with rather advanced middle-income developing links to trade infrastructure and a policy instru- economies. ment providing suitable trade and regulatory re- The review of experience with EPZs yields gimes. The usual objectives of EPZsi are to earn several lessons: (1) economywide duty-free im- foreign exchange and to create employment port systems should be emphasized over specific through exports of manufactured goods. An EPZ EPZs; (2) support to El'Zs should be considered can achieve this by attracting local and foreign individually for each economy, in the context of investors who bring with them a package of man- broader trade policy reforms involving a shift agement, technology, and marketing skills and toward Dutward-oriented development, mnainly international connections. Even undler the most as a transitional instrument for helping economies favorable circumstances, the impact of an EPZ is enter world markets; and (3) private development limited, however, by its small area, generally rang- and marnagement of EP.Zs is to be encouraged, and ing from 10 to 300 hectares. (This is a deliberately when public development is required, special ar- narrow definition and corresponds roughly to rangements ought to be put in place to ensure full what some would call "fenced-in" EPZs. It ex- cost recovery (development costs, including land cludesmanyquitedifferentarrangementsthatare rents, aad operating costs) and efficient manage- sometimes considered EPZs.) 1 The benefits of EPZs and manufactured ex- A major disadvantage of EPZs is their location- portsincludedirectones, notablyforeignexchange specific enclave nature. It is difficult to manage the earnings, employment, income, and spilloverben- estate development, promotion, and services well efits, including learning by locally owned firms; enough to attract investors and to offset EPZ training, skills, and know-how acquired by local development costs. EPZs have had a mixed and people employed there; learning by foreign inves- often disappointing record of performance in tors and buyers about the economy as a source of economies just breaking into manufacturing for manufactured exports; and the upgrading of the export because of mistakes in location and policy capabilities of local suppliers and officials in re- regimes for EPZs, although there are a few notable sponse to exacting foreign demands. In addition, cases of success such as the Dominican Republic, an EPZ can have demonstration effects, by show- Malaysia, and Sri Lanka. EPZs also have been ing the benefits of a more open approach to trade used at a somewhat later stage of development by and of an outward-oriented supply response for a few economies with substantial sophistication economies with an inward-oriented tradition. In- in trade policies and public administration, as part deed, EPZs should be evaluated in part according of a larger package of export development mea- to their dynamic contribution to continuing policy sures designed to attract foreign inv,estment in reforms, but this is difficult to do because it is electronics and other technically challenging in- virtually impossible to determine what would dustries. Foreign investors often prefer the EPZ to have happened had no EPZs been created. While other duty-free instruments, so the simultaneous several other instruments have the potential to use of several administrative instruments is fairly provide simnilar benefits, an EPZ is the easiest common, with each serving the requirements of system to arrange well for rapid clearance of im- different investors. ports and exports, and its small area makes it easier to provide a favorable, lightly regulated World Bank Group projects environment suitable to foreign investors than can be provided in many varied locations at once. The World Bank Group's (including the IFC) sup- For economies at an early stage of economic port for EPZ projects has amounted to about one- development with limited administrative capa- fifth of 1 percent of its total lending for industry bility, high distortions, and little local technologi- since 1975, an amount consistent with the rela- cal, marketing, or management capability, EPZs tively minor role of EPZ exports in developing can be an appropriate way to attract foreign and economies' total trade. Since 1977, the BankGroup domestic investment to export-oriented manufac- has provided $87.5 million for six EPZ projects in turing in a limited geographic area. Besides pro- five countries (Colombia, the Dominican Repub- viding a superior policy environment, EPZs offer lic, Jamaica, Kenya, and Thailand). Over 40 per- reduced transaction costs by providing rental fac- cent of these funds ($36 million) have been chan- tory buildings and factory sites with convenient neled to private developers of EPZ sites in the links to international trade, communications, other Dominican Republic. Three projects :have been utilities, and services at low cost to investors. completed, and three (two in the Domirican Re- However, the EPZ cannot itself induce an inflow public and one in Kenya) were approved only of foreign investment if foreigners are not inter- recently, in 1989 and 1990. Of the completed ested in investing in the economy because of their projects, two have been reasonably successful (Ja- unfavorableassessmentofthelocalbusinessenvi- maica and Thailand), while the third (Colombia), ronment, including political and social stability a 1978 project, had problems with site selection, and physical trade infrastructure. Most develop- estate development and management, arnd delays ing economies that desperately need foreign in- in the establishment of a legal framework for the vestment in their export activities lack the favor- EPZ policy regime. The World Bank seems to have able business environment that is critical for at- learned from the Colombia project and applied tracting it. Thus, an EPZ may not be appropriate in those lessons in the four subsequent projects. all casesand should usuallybe considered mainly It should also be noted that World Bink sup- as a way to attract foreign investors into export port for these later projects was part of a broader industries. And in most cases, an EPZ should be policy dialogue and action program on trade lib- part of a larger set of instruments and policy eralization. In the five countries where the World measures for developing exports. Bank Group has supported EPZs since 1981, it has 2 also supported general import liberalization engaged in manufacturing in developing econo- through twelve other projects and reform of mies. Wages in the zones tend to be equal to or economywide duty-free systems through at least higher than wages forcomparable jobsoutside the one lending operation in each country. zones. Working conditions also tend to be better. The same labor laws apply inside and outside the Experience with EPZs zones, but labor unions are rare in E.PZs, and organizing activities are discouraged in some There are at least eighty-six fenced EPZs now EPZs. operating intwenty-seven developing economies. In their early years and even later, EPZs have Their exports were aroumd $11 billion to $13 bil- had very few links with the rest of the economy, lion in 1983, and somewhat higher in 1989. Since exceptforinfrastructureand services-theywork the detailed information necessary to make even because they are enclaves. A few that have devel- an imperfect cost-benefit analysis is available for oped stronger links had a strategy of lproducing only a few zones, only a r ough assessment of the intermediate inputs at internationally competi- success of EPZs can be made, based primarily on tive prices and quality. For this to happen, the the number and type of investors that zones have producers of those intermediate goods, materials, attracted, the direct employment they have and components need to have access to their own achieved, .nd information on their exports, occu- inputs at world prices and to be encouraged to pancy, unusual costs, and problems. build world-class plants at efficient scale. Only about sixty of the zones have been in There is general agreement that the transfer of operation long enough to permit an evaluation of product and process technologies through EPZs is their success based even on such rough criteria. small, except perhaps in simple industries such as About 40 to 50 percent of these (twenty-five or garments. The most important technology trans- more zones) appear tobe successful,about 20 to 30 fer effects are in management and technical skills, percent partly successful, and about 30 percent and occur as local employees in the firms learn unsuccessful. Most of the unsuccessful zones were from foreign managers, technicians, and buyers, established in the 1970s, when economies were and from experience. Skill transfer to the rest of still experimenting. These zones have had the the economy occurs mainly through the move- greatest difficulty attracting investors and have ment of people who have received training in the suffered from exceptionally high initial costs, low zones and through work that firms outside the occupancy, meager employment, overbuilt facili- zones do for firms in the zones. If the business ties, and poor export performance. Many have environment outside the zones is not attractive, had to be subsidized continuously. The successes however, these skill transfer effects tend to be include albout half the EPZs in Asia, which ac- unfruitful. count for 71 percent of EPZ employnment, and A major concern about EPZs is that they may several E]'Zs in the Dorninican Republic, which delay needed economywide trade reforms. Much has 21 percent of EPZ employment, but no more depends on the political circumstances and pro- than two to four in the rest of Latin America and cesses. Successful EPZs increase exports, and in- the Caribbean and none in Africa or the European creased exports can give a country greater confi- and Middtle Eastern Region. dence and the resources to undertake trade policy The performance of public sector EPZs has reforms, or they can allow it to muddle along beendisappointing, exceptin Asia, where all EPZs without reforms. The direct effects of EPZs on are public, and a few in Latin America and the trade policy appear to have been positive on bal- Caribbean. The successful public EPZs in Asia ance in Malaysia, Sri Lanka, and Taiwan (China), work in part because they have been managed but uncertain in the Dominican Republic and flexibly, akin to a private business, with profit- elsewhere. As an economy develops an effective making as an objective. Because of the more nega- economywide free trade regime and minimally tive experience in Latin America, newer EPZs regulated market mechanisms, EPZs should di- there have been owned ,nd developed privately. minishin importance asa policy instrument. What Private zones generally operate without subsidies this means for World Bank policy is that EPZs or exceptional assistance from the government. should be supported as an initial or complemen- In 1990, EPZs worldwide employed about tary part of a package for broader trade and regu- 530,000 people, a tiny fraction of the labor force latory reform. 3 Another concern about EPZs is that they dis- generallyina majorurbanarea, with sdi¢able low- criminate against firms that are not in the zone. cost labor, transport (major port, good riads, and Initially, the EPZ is an enclave that gives its firms an international airport), utilities (electricity, wa- special advantages - duty-free imports for ex- ter, sewage, and reliable telecommunications), and port production, less red tape and regulation, services (maintenance, security, banking). Also links to physical infrastructure, and, sometimes, importantare good zone administration and man- added tax incentives. In return, firms in the zone agement (including phased construction of sulit- are generally required to export all or nearly all of able factory spaces for rent as well as cornplernen- their output. EPZs seek to put their firms on an tary facilities) and appropriate promotional ef- equal footing with international competitors, forts. which typically enjoy free trade status in lightly Failure or poor performance of EPZ', on the regulated market economies with favorable busi- policy side has been associated with inappropri- ness conditions. Local export firms outside the ate or ineffective formulation of policies or their EPZ are discriminated against notby the existence implementation, such as an excessively it iterven- of the EPZ but by the distortions and excessive tionist and rigid regulatory environment and ex- regulations in the local economy. But local export- cessively time-consuming customs procedures. ers outside the EPZs need free trade treatment and On the industrial estate side, problems have re- a liberal regulatory environment too, and the sulted from poor site selection (including tying to sooner the better. create EPZs in economies with an unfavorable A third concern is the environmental impact of business environment or poor trade infrastruc- EPZs, but this worry appears to be unfounded. ture) and unsatisfactory zone managemrnent (in- There is no evidence that EPZs systematically cluding building too many structures a head of exempt firms from environmental regulation or demand). Inadequate promotion has also been that firms that locate there are heavy polluters. important in contributing to low occupancy. Indeed, control of pollution and disposal of haz- ardous industrial wastes are generally easier and Role of the World Bank cheaper in a well-managed industrial estate than in dispersed firms. Thus, where environmental The Bank's emphasis on economywide duty-free problems exist, they stem from economywide import systems as an alternative or complement policies and resource use. to EPZs will continue. EPZs should be seen as just one instrument -- and one with limited applica- Lessons from experience bility - among many for export development, import reform, and regulatory liberalizatioon. In a Experience suggests that certain policies are par- variety of circumstances an efficient in-bond or ticularly important for EPZ success. A realistic duty-exemption system may well be more appro- exchange rate and a stable macroeconomic envi- priate than an EPZ, which is difficult to locate, ronment are crucial for all manufactured exports. develop, and manage. When the World Bank con- Also important for firms in the EPZ are (1) clear siders an EPZ project it should ensure that the policies toward foreign investment, including the preconditions and policy orientation are in place possibility of 100 percent foreign ownership and for a successful EPZ, that entrepreneurs and poli- guaranteed repatriation of profits and speedy re- cymakers understand the task, and that each EPZ sponsestouncomplicatedinvestmentapplications; is part of a coherent package and sequence of (2) unrestricted access to duty-free imported in- measures to develop manufactured exports, sup- puts and capital goods and rapid, low-cost cus- ported by further measures for regulatory liberal- toms clearance for imports and exports; (3) no ization and macroeconomic stability. The Bank restrictions on foreign exchange for EPZ firms' has very limited supervision capabilities and little export-related international transactions; (4) mini- detailed know-how for making an EPZ success- mal regulatory interference in the actions and ful. Therefore, it should be selective and cRutious transactions in the EPZ, including freedom to hire in supporting EPZ projects. and fire workers at low transaction costs; and (5) EPZs may be most valuable as an interri mnmea- extension of free trade status to EPZ estate devel- sure for initiating economies into world r-iarkets opment and management. On the industrial es- for manufactured goods while more desirable tate side, key factors are appropriate location, economywide policies are being implemented. 4 The Bank should continue to support EPZs on a a national perspective the risks and costs of rely- case-by-case basis. Support is most likely to be ing on fenced EPZs largely disappear when pri- appropriate where the EPZ can be supported as vate entrepreneurs assume responsibility for de- part of an integrated strategy for trade and regu- veloping and managing EPZs. Private investors latory reforms and where there are no feasible will not locate in unpromising areas, so theprivate alternatives for attracting local and foreign invest- development and management of EPZs is a realis- ment and other types of foreign collaboration on tic option only in economies that already offer export activities. Also important is the availablity favorableenvironmentsforlabor-intensivemanu- of suitable physical trade infrastructure and a factured exports. In an economywherebasic trade policy environment that fosters - or at least does infrastructure is deficient, the development of nothinder-privatesectordevelopment.Inecono- good physical trade infrastructure is a necessary mies that already have substantial and growing complement to the EPZ. exports of labor-intensive manufactures to OECD When, in exceptional circumstances, the Bank countries, the Bank should support EPZ projects finances construction of an EPZ industrial estate only in exceptional circumstances (part of an developed by the public sector, full cost recovery economywide institutional reform) and only as and efficient management are cruciLIly impor- part of a larger package of well-aimed policy tant. Experts and practitioners with proven track measures or through-lending to private EPZ de- records in all aspects of EPZ development should velopers, as in the 1989 loan to the Dominican play significant roles in the project. Project com- Republic. ponents and conditions relating to funding, man- Where establishment of an EPZ looks promis- agement, and promotion of the EPZ are essential, ing, the Bank should lean strongly toward devel- as are flexibly phased construction schedules, opment and management of EPZs along profit- driven by occupancy rates, demand for space by making lines, preferably through foreign or do- investors, and progress in assessing and approv- mestic pri vate ownership and management. From ing investment proposals. 5 _ ~~1 Export processing zones and policy reform This paper examines export processing zones ward outward-oriented development. Reliance (EPZs), one instrument among many for imple- on the EPZ asapolicy instrument should,diminish menting policies for export development, import over time, as aneconomybecomes successful in its reform, and regulatory liberalization. EPZs may outward-oriented strategy, though its value as an be most appropriate for an economy striving to industrial estate may remain. develop manufactured exports but unable to rap- Three basic elements are critical for a develop- idly overcome economywide deficiencies in its ing economy's entry into the world m,arket for policy environment. Such an economy may be manufactured exports: able to create the proper environment in the lim- * A suitable macroeconomic, exchange rate, ited area of an EPZ needed to attract export- and trade policy regime, together with a legal and oriented investment. This analysis of EPZs, which regulatory environment favorable to business. are here rather narrowly defined to correspond * Adequate physical trade infrastructure (such as roughly to what are often called fenced-in EPZs, sea, air, and road transport systems and commu- separates the policy side of EPZ operations from nication facilities) and public utilities (such as elec- the industrial estate aspect. (The appendix pro- tricity and water). vides a historical perspective on the origins of * Technical, marketing, and managerial know- EPZs and their proliferation and three tables on how and adequate links to the international market the eighty-six EPZs now in operation in twenty- network, along with financial and other resources seven economies.) for capital investments. Experience indicates that economywide duty- free import systems should be emphasized over Rational trade policies specific EPZs and that support to EPZs should be considered on an individual basis, taking into Economic policies in most developing economies account the crucial relationship between the suc- handicap potential exporters, making it impos- cess of an EPZ and the overall policy and infra- sible for them to compete on world markets for structureframework. Privateownershipandman- industrial goods on anything close to mn equal agement of EPZs is also to be encouraged, and footing with their foreign competitors. UTsually when public ownership cannot be avoided, spe- the incentive structures are biased against pro- cial arrangements ought to be put in place to duction for export. Where there are tariffs and ensure full cost recovery (including land rents and other taxes or restrictions on imports of producer operating costs) and efficient management. The goods, export development policies must provide EPZ's main role is as a transitional instrument, exportersfree trade status, which their competitors enabling a country to enter into world markets enjoy (at least for imported inputs) around the while undertaking policy reforms to shift it to- world. And, while more general policy reforms 6 are pursued for the entire economy, exporters sites, business services, utilities, and easy access to need a liberal regulatory regime (covering invest- air and sea transport as well as unrestricted access ment, con-ipany ownership, foreign exchange, hir- to imported inputs, equipment, and spare parts.' ing and firing, labor requirements, and the like) as Customs administration in EPZs should also be a transition measure. simple, mainly checking arriving and departing Since 1979 the Bank has advocated three pri- containers and preventing unauthorized trade mary measures of trade policy reform (Thomas, between EPZs and the domestic economy. EPZs Matin, and Nash 1990): can generally be set up and running effectively * Maintaining a realistic exchange rate and faster than other duty-free instruments, which sound macroeconomic policies. require much training, testing, experience, and * Establishing export policies to ensure free adjustment before they are working wvell at a low trade status for direct and indirect export activi- enough cost to exporters. Key disadvantages of ties. the EPZ are its location-specific enclave nature, * Reforming import policies to reduce protec- which limits benefits to firms inside the zones, and tion for import-substitution industries and free the difficulty of managing estate development, imports from controls. services, and promotion well enough to attract Thefirst two measures helpputexporters on an investors and offset costs. equal foDting with foreign competitors without An in-bond system is the other special altema- violating the rules of the General Agreement on tive for firms that manufacture for export. It tries Tariffs and Trade (GATT). The third - reformning to give firms free trade status and provide for import policies - reduces antiexport bias. The rapid delivery of imported inputs and outputs Bank has also discussed other desirable measures without restricting firms to a specific location. that offer exporters special treatment until suit- While its objectives are practically identical to able conditions can be created economywide.' those of an EPZ, it typically offers a smaller pack- Several administrative instruments can pro- age since it is impractical to provide infrastruc- vide free trade status for direct export activities ture, services, and a liberalized regulatory and and, with suitable supplements, for indirect ones business environment in widely separated loca- as well in economies with tariffs or other trade tions. Instead, the in-bond system relies on com- barriers. These include anexport processingzone, plementary private sector efforts to provide facili- an in-bond system, a duty-exemption (or tempo- ties and services and on honest and helpful service rary import) system, and a duty-drawback sys- by public officials. In-bond systems, like EPZs, tem. Since each of these instruments serves firms generally apply to firms that export their entire indifferentcircumstances, mosteconomiesoffera output, but both systems may provide for a cer- choice of two or more of them. Such systems need tain percentage of sales to the local mLarket. Unlike to be easy to understiand, and their procedures EPZs, which are confined largely bt developing must be automatic and transparent, to avoid the economies, in-bond systems are available in de- discretionary elements that lead to delay, uncer- veloped market economies as well. tainty, and corruption.. Mechanisms for prevent- Customs administration of an in-bond system ing misuse of duty-free imports (sale of duty-free can be based on either continuous physical checks imports in the protected local market) are also or document review and spot checks. Under a importint since misuse results in revenue losses system of continuous checks, customs officers and special favors. supervisebonded manufacturingwwarehousesand An export processing zone is an industrial estate, monitor the use of duty-free goods in each plant. usually a fenced-in area of 10 to 300 hectares, that Indocument-basedsystems,customsofficersmake specializes in manufacturing for export. It offers unscheduled visits, relying on spot checks of the firms free trade conditions and a liberal regula- plant's documentary records and goods.3Partlyin tory environment. Its objectives are to attract for- reflection of these contrasts, in-bond systems vary eign investors, collaborators, and buyers who can widely in flexibility and effectiveness. They are facilitate entry into the world market for some of used in thirteen or more of the twenty-seven de- the economy's industrial goods, thus generating veloping economies that have EPZs, including employment and foreign exchange. An EPZ is eight of the nine in Asia. intended to meet the requirements of the foreign Unlike the usual in-bond or duty-exemption investors for readily available factory space or system, Mexico's maquiladoras and Mauritius's so- 7 ,t called Export Processing Zones (unfenced export tradeoff between speedy processing and prevent- processing zones) rely primarily on firms' decla- ing misuse of duty-free imports. Modemn informa- rations of imports and exports. Mexico's maquila tion technology facilitates processing only if system is a special case that exploits the combina- pretabulated input coefficients are available. Physi- tion of low-cost labor, a common border with the cal checking mechanisms of EPZs or some in- United States, and special U.S. customs provi- bond systems (that do not require information on sions. Mauritiusbenefits frombeing a small island input-output coefficients) can be viewed as in- economy that receives preferential treatment from terim or complementary measures, to be used as a the European Community (EC). Its garment ex- country develops the skills to apply document- port industry was started by HongKong investors checking mechanisms. interested in avoiding export quotas in the indus- The Bank has recommended that economies trial countries. Mexico's system is assisted by offer both an exemption system and a drawback modem computerized documentation and proce- system to provide duty-free imports for export- dures that allow most containers to clear customs ers. Since delays and difficulties in using these rapidly. Mexico's maquiladoras and Mauritius's systems are common, while most export produc- unfenced exportprocessing zones together gener- ers need rapid access to inputs, the Bank has ate as much employment and more exports than recommended that economies also offer an in- all the EPZs in the rest of the developing econo- bond system or an EPZ - or both - for firms mies.4 Somewhat similar to these in-bond systems specializing in manufactured exports. The Bank or to duty-exemption systems are the "special has cautioned, however, that certain EP.Zs were economic zones" in China, which provide export- poor investmentsbecause of unwise location, high ing enterprises with special duty-free import re- investment costs, mediocre management, or un- gimes over a limited territory.5 cooperative customs officials. Especially important for export development are economywide systems that apply to a much Infrastructure and industrial estates wider range of exporters. Under duty-exemption systems (including temporary admissions, deferred Good physical trade infrastructure (ports, trans- drawbacks, advanced licenses), which waive not port systems, and communication facilities) is only import duties and indirect taxes but also essential for any export activity. Although an import restrictions, firms are obliged to export industrial estate or EPZ can be developed and products corresponding to their duty-free managed by a private enterprise or a public au- imports within a specified time period, based on thority, public investments are critical for build- documentary checking mechanisms (including ing the overall trade infrastructure in developing input-outputcoefficients).6Duty-drawbacksystems economies. This is true even in virtual free ports are usually based on documented evidence of such as Hong Kong and Singapore, where this duties and indirect taxes paid on inputs and on infrastructure is world-class. input-output relationships in export production.7 Many exporters under the various duty-free The most efficient duty-exemption systems, when regimes (and also in virtual free ports) operate used in conjunction with industrial estates, result from factory buildings in industrial estates. The in arrangements that have some similarities to EPZ, however, is the only duty-free instrument EPZs. They lack, however, the special, liberal regu- that regularly includes factory buildings for rent latory environment of the EPZ, although some and factory sites for lease along with the other countries offer special exemptions from regula- facilities of an industrial estate. In addition to tory restrictions to all firms that export at least a possible economies of scale and the shorter time specified percentage of their output. required to make it work effectively, a physically Duty-exemption, drawback, and some in-bond delimited EPZ has the advantage of being able to systems rely heavily on input-output coefficients provide, in a small area, the type of free tra,de and for customs documentary checking.8Many devel- import restriction-free, lightly regulated policy oping economies lack the technical capabilities to environment that cannot yet be created for an derive these coefficients systematically and the economy's entire area. Actual economies of scale administrative capability to handle them prop- and scope come from concentrating expart-ori- erly. As an alternative, they tend to rely on firms' ented investors in a small area and supervising declarations. As a result, countries may face a customs activitiesina "showcase"situation,where 8 compalints are likely to be heard and failures to be industrial estate, generally make it more attrac- visible. tive to foreign investment than a location else- where in the economy. But while good manage- Foreigni direct investment ment of both the policy and the industrial estate aspects of an EPZ are important for attracting One feasible way for a developing economy, par- foreign investment, an internationally competi- ticularly e! small one, to supplement its insuffi- tive business environment is also essential. In cient export manufacturing and marketing know- practical terms this means a policy environment how and to develop links to the international that does not get in the way of private sector market network is to collaborate with foreign development, low real wages relative to worker investors. The foreign investors contribute not performance, easy access to external nmarkets and only capital but, more important, a package of to inputs for export processing, good physical marketing and technical know-how, access to estab- trade infrastructure, and a reasonably favorable lished overseas market networks, and the manage- living environment. Readily available informa- rial capacity to combine them with local resources. tion on the EPZ and the host economy and on local An EPZ's free trade status and liberal regula- firms that are potential suppliers or collaborators tory environment, combined with an efficient is also important. 9 World Bank experience with export processing zones Since 1977 the World Bank Group has provided Operational aspects US$87.5 million for six projects supporting EPZ estate construction or EPZ facilities and infra- The World Bank's experience with industrial es- structure infive developing countries (see table 1). tate construction for EPZs has been mixed. in three The six operations include four by the Bank, one projects (Colombia, Jamaica, and Thailand). Two by the International Development Association (in projects became reasonably successful (Jamaica Kenya), and one by the International Finance Cor- and Thailand), thanks to favorable environments poration. for EPZs and for manufactured exports. One Two completed projects and one new project project was a failure (Colombia). have involved construction of public sector EPZs: The Lat Krabang industrial estate project in the 1978 Cartagena EPZ project in Colombia, the Thailand, which was financed by a Blank loan 1983 Kingston Free Zone project in Jamaica (the approved in 1977, had anticipated that 12 percent zone, started in 1976, was already operating at the of the estate would be designated as an EPZ. The time of the loan), and the 1990 Kenya Export estatewasonlypartiallyfilledatfirst,butdemand Development project (which earmarks US$22 for estate factory space increased within a few million for the construction of an EPZ at Athi years, and the estate was expanded significantly River). This Kenya project was part of a larger (without Bank lending). Today 27 percent of this policy package to improve trade policy and foster expanded area is an EPZ; 73 percent o f the EPZ export development. was added after the initial Bank project. In 1990 The Bank was also directly involved in a 1977 the estate had roughly 36,000 workers, over a industrial estate project in Thailand with a small quarter of them in the EPZ. EPZ component (under $1 million) that was ex- The Cartagena Free TradeZone loan, approved pected to include 12 percent of the area of the in 1978, was the Bank's first attempt to sFecifically industrial estate. Two recent EPZ operations in finance an EPZ. It has been a failure for a number the Domfnican Republic have supported private of reasons, including poor site location, estate developers. One is a 1989 Bank project to channel development, and public management, as well as funds to private EPZ developers for standard policy failure (see below)."0 Cartagena is a small factory shells and other facilities through an exist- port city, far from the country's main urban cen- ing financial intermediary. The second is a 1989 ters. EPZs rarely succeed in that type of location. International Finance Corporation (IFC) invest- Finding land for the zone proved difficult because ment in, and loan to, the private San Isidro EPZ.9 local authorities and the business community opposed most locations. A mangrove swamp was finally selected for the site, resulting in high devel- 10 Table 1 World Bank export processing zone (EPZ) projects, 1977-90n EPZ component amount (total Project objective of EPZ component Type of project amount) EPZ industrial EPZ enterprise Country Year Project nanme loan (US$ millions) estate development developmrent Thailand 1977 Lat Krabar.g IBRD 0.95 Small part of industrial Industrial Estate (4.75) estate site development (including estate infra- structure) to be designated for EPZ Colombia 1978 Cartagena EPZ IBRD 15 EPZ site development and (15) construction of buildings (including EPZ site infrastruc- ture, training center, and technical assistance for promotional activities) Jamaica 1983 Kingston Free IBRD 13.5 EPZ site development, con- Zone Develop- (13.5) struction of buildings, training, ment and technical assistance) Dominican 1989 Industrial Free IBRD 30 Loan to FIDE for onlending Technical aissistance to Republic Zone Development (30) to private EPZ developers; support strategies technical assistance to for future E.PZ develop- support strategies for ment and increase future EPZ development backward linkages Dominican 1989 Investmeit in IFC 6 Loan to a major private EPZ Republic Zona Franca (6) developer to expand factory San Isidrco, S.A. space for lease Kenya 1990 Export Development IDA 22 EPZ site development (100) (including estate infra- structure) opment costs. By 1989 employment had reached publicEPZatMontegoBayandprivateEPZsinand 716 peop:Ie in nineteen small firms, far short of the around Kingston. EPZsinJamaicanowemployover 5,000 to 6,000 jobs fores,een in the project objec- 15,000 people and their exports constitute about 20 tives. Exports reached $10 million in 1989, a frac- percent of Jamaica's exports. tion of the projected values of $50 million to $60 The other three EPZ projects date from 1989 million a year (in 1978 prices; over $150 million in and 1990 and are too new to be adequately evalu- 1989 prices). ated. It should be noted, however, that the Kenya The K:ngston Free Zcne project started in 1976, project, though built with public funds, is to be seven years before the Bank became involved. privately managed. Since the mid-1980s, the Bank Operation of the EPZ began with 140 employees has enforced its environmental, health, and safety in 1980. 'Nhen the Bank came to its assistance in guidelines in all EPZ projects. (See box 1 for a early 1983, the EPZ was not yet successful and discussion of cross-country experience with the employed only 875 people. Because of its poor operational aspects of EPZs.) design and small developed area, the zone be- came crowded; it also experienced tense labor Policy aspects relations." Despite these problems, employment rose to 11 ,000 in 1987 before dropping back to 7,441 A basic framework for an EPZ policy regime was in 1989 -- considerably more than the 4,000 jobs in place in the Dominican Republic, Jamaica, and projectecl for 1990. The zone's success in generating Thailand prior to the Bank projects. Five free employment has led to the development of a second zones existed in Colombia at the time of the 11 Box 1 Experience with operational aspects of export processing zones Buildings - mainly standard factory buildings - consti- parking spaces, and a high fence around the developed tute 75 to 80 percent of industrial estate construction costs part of the zone. Getting telephone lines is no small accom- of EPZs in Caribbean Basin countries with good physical plishment in many developing economies, where appli- trade infrastructure and general-puzrpose public utility cants must typically wait several years for such a line. facilities. There and elsewhere EPZ construction costs Phased construction in response to demand for space generally exclude construction of economywide trade in- has been a key to the success of EPZs. Many early EPZs frastructure (seaport and airport facilities, roads, and com- overbuilt their facilities ahead of demand, encountered munication facilities) and utilities outside the EPZ and its lowoccupancy rates, and never recovered the costs. There access roads. indeed, these facilities are critical for expand- is also a size range that seems to yield best results, fromn no ing industrial exports both inside andl outside EPZs. smaller than 15 hectares to around 200 hectares, although Successful EPZs are usually within 20 to 25 miles or an the Tanjung Priok zone in Jakarta has 11,000 garment hour's drive of both a major international airport and a workers on only 10 hectares. Services are yet another key major port, and they are conveniently accessible by good to EPZ success. Well-managed zones provide the services roads. Successful EPZs are located in major metropolitan that firrms in the zone need most, including sanitation, areas that offer abundant low-cost labor, reasonably good waste disposal, and maintenance of various kinds. A zone infrastructure, and a wide range of services useful to EPZ islikely ioincludemany otherservicefacilities, such as fire firms. Also important are adequate medical and school fighting, banking and postal facilities, job referral, cater- facilities and reasonably pleasant living conditions and ing, day-care centers, training institutions, and standiard housing for managers and their families. Zones located in business services. Usually the zone management stands backward regions with the intention of accelerating their ready to assist firmns in their dealings with public authori- development have yielded poor returns, as have zones in ties, public utilities, and businesses and service suppliers small cities far from major centers of activity. When a outside the zone. poorly located EPZ has required construction of much The zone management and its services and business new physical infrastructure, such as dams for electric sense are crucial, but so are the energy, skill, and resources power and even houses, new community development used to promote the zone to prospective investors. Urtless costs have been exorbitant. suitable investors can be attracted, the rest goes for noth- Along with an appropriate site on slightly sloping or ing. level terrain with gooddrainageabovesolidground, EPZs The most frequent sources of EPZ failure stemming must provide utilities (electricity, water and sewage, tele- from theindustrial estate side have been poor site selection phone and fax communications, with at least two or three (including trying to create zones far from major cities and lines per plant), access roads, standard factory buildings in economies with a severely unfavorable business envi- for rent, sites for investors who prefer to lease land and ronment, serious political instability, or poor physical build their own plants, and auxiliary facilities ranging infrastructure); unsatisfactory management; and iniad- from administrative and service buildings to a bus stop, equate promotion campaigns. Cartagena project in 1978, but there was no EPZ liberalization comes from the confidence -- and policy regime. Instituting such a policy regime foreign exchange -- acquired from exporting. In was not one of the Bank's loan conditions at the turn, import liberalization makes export indus- time - Colombia's present EPZ law was enacted tries more competitive with import-substitution in 1985. This was one of several factors that de- industries at home and with other countries' ex- layed foreign direct investment in the zone - ports in the world market. In practice, the Bank twelve of the foreign firms that were in the zone in also emphasizes establishing and improving 1989 came only after the EPZ law was enacted. For economywide duty-free import systems. Since the Kenya EPZ project (1990), the Bank required 1981 there have been at least forty-three loans and an EPZ policy framework as a condition of the credits in thirty-three countries for structural ad- loan, and Kenya enacted EPZ legislation in 1990. justment, trade policy, export development, and In the last decade, a satisfactory legal framework the industrial sector that have included compo- has existed before the Bank has approved loans nents for reforming economywide duty-free im- for EPZ projects. port systems. In each of the five countries with A basic premise of the Bank's advice on export Bank Group-supported EPZ projects, at least one and import policy reforms is that export and gen- lending operation has supported reform orf at least eral import liberalization should reinforce each one economywide duty-free system, and tle Bank other. Much of the impetus for further import has also supported general import liberalization 12 in at least twelve projects in those five countries. the IMF, the Bank has also sought to create realis- The December 1990 EPZ project for Kenya, for tic exchange rates and stable, sound macroeco- example, required reforms in both the nomic policies. (See box2 fora discussion of cross- economywide duty-free import system and gen- country experience with the policy aspects of eral import liberalization. Working closely with EPZs.) Box 2 Experience with policy aspects of export processing zones Speedy and reliable access to imported inputs at low cost tronics,whereequipmentiscostlyandtechnologicalchange appears to be the most critical element for increasing the is swift, it is essential to allow new equipnment to be ability of firms to get required inputs on time to meet exported as well as imported, at any time, free of taxes and delivery deadlines and to reduce waiting time and inven- restrictions. Other requirements include a liberalized for- tory costs, which can be a significant part of total produc- eign exchange regime for exporters; unrestricted travel for tion costs. Thus, rapid, low-cost customs clearance for managers and technical personnel; application forms and imported inputs and exports is a must. Restriction-free procedures for investors that are not unduly complex and and tax-free import of capital goods and spare parts is also demanding; speedy responses to investment applications; crucial. Beyond that is the need for a clear foreign invest- and extension of free trade status to EPZ estate develop- ment plicy regime that permits 100 percent foreign own- ment and management, so that construction equipment ership and guarantees the repatriation of profits and the and materials, transport equipment, and the like can be prompt payment of liabilities in foreign exchange. imported duty-free. In the zone, property rizghts must be clearly defined and Key causes of failure or poor performance on the policy reliably guaranteed, andregulatoryinterventions andcon- side have been the tardy formulation of required policies, trols should be minimal, to avoid costly or unreasonable an overregulated and rigid regulatory environment, and delays by regulatory authorities. The right to hire and fire inappropriate laws andregulations affecting EPZs-rigid, workers at low transaction costs is particularly important. time-consuming, and irksome customs procedures are a Transactions between firms in the zone should be left case in point. virtually unregulated. To attract industries such as elec- 13 Global experience with export processing zones Benefits, costs, and perfo\mance indicators There havebeen few detailed cost-benefit stud- ies of EPZs. The best known are summarized in a An EPZ can bring both direct benefits in the form recent study in the World Bank Research Observer of foreign exchange earnings, employment, and (Warr 1989).3Even though spilloverbenefits were income, and spillover benefits, in the form of not taken into account, the study found rates of learning and imitation by local firms, training, return in Malaysia's Penang zones and in and on-the-job experience, which can lead to tech- Indonesia's Tanjung Priok zone that are nearly as nology and skill acquisition by local employees high as those in Korea's Masan zone. It iFound and growing interest in the economy by foreign negative returns in the Philippines' Bataan zone. investors and buyers. Positive effects can also be No formal attempt at a cost-benefit assessment created by backward links, as a result of exacting is made here because detailed information is not demands forinfrastructureand servicesand some- available for most zones. Enough informration is times for local inputs and processing by firms often available, however, on direct employment, outside the zone. An EPZ may also have a positive the number of firms or factories operating in the spillover effect through learning by government zone, or other details to provide a rough indica- officials about the needs of investors and the ad- tion of success in some zones.'4 A crucial point ministration of simplified regulations. There is about EPZ performance is that EPZs thalt fail to also usually a positive effect on poverty, since achieve a high occupancy rate do not generate most of the jobs created go to people from poor enough direct or spillover benefits to justify their households. Experience around the world sug- construction and development. EPZs with largely gests that a successful EPZ remains active and empty facilities after ten or fifteen years of opera- continues to yield direct benefits for more than tion must be counted as failures. Exceptionally twenty years, while the spillover benefits are con- high initial costs and a continuing need for subsi- centrated mainly in the first decade. dies are another sign of failure, even if employ- The rate of return or net benefit, if any, depends ment is high. on how the benefit compares with the cost, par- ticularly the cost to the public sector, but also to Successes and failures around the world the private firms involved. Evaluating costs and benefits from an economic perspective requires About sixty of the eighty-six zones in twenty- attaching suitable values to the benefits as well as seveneconomieshavebeenoperatinglongenough the costs, taking into account the opportunity to permit tentative judgments about their success. costs of the resources involved."2 It iis very difficult Based on such rough criteria, twenty-five cf these to get a good measure of the spillover benefits, zones appear to be predominantly successful (in- however. cluding several that are clearly outstanding), an- 14 other ten come close, seven are partly successful, Caribbean Basin region. In Costa Rica EPZ em- and eighteen are clearly unsuccessful. Most of the ploymentgrewfivefoldbetween1986and 1990; in unsuccessful ones date from the 1970s, when the Dominican Republic, it tripled; and in Ja- economies were experimenting with this instru- maica, it roughly doubled. Three of the five EPZs ment - mistakes have been fewer and smaller that employ 30,000 or more are in Asia (the largest with the more recent zDnes.'5 has over 45,000), and the others are in the Domini- can Republic. Success. Almost all the successful EPZs are in the AsizL region (eighteen of them) or in the Do- Exports. Most of the developing economies' minican, Republic and Jamaica, where at least six manufactured exports, which totaled $258 billion appear predomninantly successful, six are on the in 1988, came from firms that enjoy free trade verge of success, and the others are new. Else- status through duty-exemption orduty-drawback where, there is only onte other clear-cut EPZ suc- systems, with in-bond systems third and EPZs cess (a small private zone at Cartago in Costa fourth.'8 The exports from fenced-in EPZs in 1988 Rica), three zones that are partly successful, and as were $11 billion to $13 billion, or 4 to 5 percent of many as fourteen that are unsuccessful. The the total.-9 In 1989 they were somewhat higher. twenty-seven zones in these other parts of the About 80 percent of EPZ exports were from Ma- world employed only 25,000 people in 1990, or laysia, Korea, and Taiwan (China). (Table A.2 in less than 1,000 per EF'Z comparable figures for the appendix shows the value of EPZ exports for Asia are 10,500 and for the Dominican Republic some developing economies in recent years. No and Janmaica, about 6,000 (see appendix). dependabledataseemtobeavailableonMalaysia's Two zones rated poorly despite generally good EPZ exports in recent years.) employment performrance: Kandla in India, which In 1989 exports per worker inmost EPZsranged requires constant subsidies (because of high trans- from about $5,500 to about $10,000; the Domini- port costs) and artificial pricing of output (ex- can Republic, for example, exported goods worth ported mainly inbarter trade with the USSR), and about $6,200 per worker. Zones in which foreign- Bataan in the Philippines, which had enormous owned electronics firms had a strong presence infrastructure and other construction costs be- achieved much higher export value per worker: cause of its inappropriate location.'6 Most zones probably well over $30,000 in Malaysia, $50,500 in that are considered partly successful have achieved Taiwan (China), $67,800 in Korea, and over $40,000 only a partial occupancy rate, and most of the (rising to $72,000 in 1990) in the Philippines'Baguio unsuccessful zones have remained virtually un- City zone. occupied. Using EPZs to promote development in backward regions has generally led to very poor Value added and net earnings from exports. Value results. added in EPZs is commonly around 25 percent or An issue that has yet to be properly faced is slightly less, particularly where zones import al- when and how to phase out EPZs that have out- most all their material inputs. Exceptions include lived their usefulness. EPZs have not been closed Taiwan (China), at over 45 percent, and the Masan down or phased out anywhere so far, and this zone in Korea, at 51 percent (including about 23 rigidity isa cause for (concern since the land might percent from locally made material inputs-about well be more valuable in other uses. one-third of the inputs used-and over 3 percent from processing by firms outside the zone). Employment. Employment in EPZs in develop- Of the 25 percent or so of value added in a zone, ing economies reached about 530,000 people in typically at least half is labor costs; some of the rest 1990 (see appendix for details by economy).'7 Of is payments for rent, utilities, transport, services, this labor force, roughly 71 percent is in Asia, 21 and goods inside the country; and some goes to percent in the Dominjican Republic, 7 percent else- the owners and their creditors (including equip- where in Latin America and the Caribbean, and 1 ment suppliers) abroad. Thus net foreign exchange percentintherestofthedevelopingworld.World- earnings for a country from the exports of a for- wide employment in EPZs has trended upward: eign-owned EPZ plant may be as low as 15 to 20 in 1973 it was arouncd 220,000, and by 1986 it had percent of the value of the exports. These shares risen to about 374,000. EPZ employment growth are, however, probably at least as large as the during the last five years has been strongest in the earnings in world prices from a country's export 15 manufacturing outside EPZs; indeed, true mar- the performance of public EPZs has been disap- gins almost certainly tend to be narrower outside pointing, although public zones in the Dominican EPZs wherever incentives and prices are seriously Republic and Jamaica are generally adeq uate for distorted. the needs of foreign and domestic garment firms. EPZs in the Americas are increasingly being Industries attracted and foreign investment. EPZs created through private ownership, development, concentrate their exports and employment in a and management.2 Since government salaries tend few labor-intensive industries, with two main to be low and government agencies inflexible and patterns. In the first pattern, electronics predomi- severely constrained in matters of fees, contracts, nates, as in Korea, Malaysia, Taiwan (China), and hiring, salaries, other personnel matters, and or- certain zones elsewhere. Other precision indus- ganization, the privately managed firms enjoy an tries are usually present as well, while garments advantage. A private EPZ development firm gen- account for about 10 to 15 percent of employment. erally does not expect subsidies or exceptional In the second pattern, garment manufacturing assistance from the government. It takes all risks, predominates, as in most of the zones in bears the costs, and tackles the problems.. These Bangladesh, the Dominican Republic, Indonesia, features are often viewed as attractive by govern- Jamaica, and Sri Lanka. ments struggling with shortages of funds and Foreign-owned firms and their joint ventures administrators. predominate in most EPZs. Domestically owned firms are also at work in almost all EPZs-in India Exchange rates and macroeconomic stabdlity. Suc- and Indonesia they outnumber foreign and jointly cess in developing EPZs has been definitely corre- owned firms. Nationals often play a substantial lated with realistic exchange rates and stable mac- managerial role in foreign-owned firms. In gar- roeconomic policies. Five of the nine Asian econo- ments, footwear, and other simple industries, for- mies with EPZs -- Indonesia, Korea, Malaysia, eign investment these days comes mainly from Taiwan(China),andThailand-havemain-tained Hong Kong, Korea, and Taiwan (China), while in fully realistic exchange rates. Their average infla- electronics it comes mainly from the United States tion rates for 1980-88 ranged from 1.3 percent and Japan. (Malaysia) to 8.5 percent (Indonesia). In the other four economies inflation rates ranged from 7.4 Performance of publicand private EPZs. All Asian percent in India to 15.6 percent in the Philippines. EPZs are public,20 and they are among the most In the Americas the leading EPZ economies ex- successful EPZs. Public management seems to hibit less macroeconomic stability. In the Domini- have worked well in Asia because the EPZs have can Republic, the main success story in the Ameri- been managed flexibly, akin to privatebusinesses, cas, inflation averaged 16.8 percent for 1980-88. with profit-making as an objective, and because Jamaica, with 18.7 percent, and Costa Rica, with most of the zone administrators have learned 26.9 percent, have also begun to realize some from each other, starting from the experience of success, thanks mainly to duty-free access to the the well-managed zones in Taiwan (China).2" The U.S. market under various incentive programs for low cost of labor in these economies at the time the the Caribbean economies, including the fiavorable zones were developed also helped. Outside Asia allocation of garment quotas. 16 4 Concerns about export processing zones Employment effects and labor legislation wageincreasesseldomacceleratebeyondproduc- tivity increases unless exchange rates become Employment of 530,00 people in EPZs in devel- overvalued. oping economies is small in relation to their total Women make up at least three-fourths of the labor force. But in particular settings the impact of labor force in most EPZs and two--thirds in the EPZs oll the surrounding labor market has been Dominican Republic.24 Women usually hold most dramatic, reducing unemployment sharply, not of the semiskilled jobs, while men are in most of only through direct creation of jobs but also the skilled and management positions. The women through demand for services and construction. in the EPZ labor force tend to be young, typically In those settings, the effects on income, growth, 16 to 25 years old, and most leave within a few and economic activity have been equally dra- years to marry and raise children. matic, not least through their foreign exchange earnings. Impacts on economywide trade reforms Wages in the zones tend to be equal to or higher than wages for comparable jobs outside the zones The influence of EPZs on econornywide trade and higher than the opportunity cost of most of reforms is especially difficult to establish since those employed. Working conditions in EPZs tend there is no way to arrive at convincing estimates of to bedistinctlybetter than those outside the zones. what would have happened without EPZs. Much Safety and health conclitions in EPZs are generally of the controversy springs from cornpeting views better than the conditions in plants outside EPZs of political processes and thus cannot be resolved in the same economies, partly because the EPZ by factual evidence on actual events and export plants are cleaner, better lighted, better venti- results. However, it is fairly clear t]hat because of lated, and more spacious. In simpler industries, an EPZ's enclave character and special features, a such as garments, wit'h inexpensive capital equip- favorable export performance is diEcounted more ment, most EPZ plants work only one shift. How- readily than are similar attainments outside an ever, some EPZ plants, particularly in electronics, EPZ. If an EPZ fails conspicuously, the reasons are work three shifts and others two, so that many often widely recognized and it typically is only EPZ workers are obliged to keep unconventional one of many failures. But its poor results can hours. sometimes contribute to skepticism about the fea- Most EPZ workers are covered by the same sibility of outward-looking policies and manufac- labor laws as non-EPZ workers. Unions exist in tured exports. If an EPZ succeeds, the increase in only a few EPZs, and in several economies EPZ exports will tend to facilitate trade policy im- workers are not completely free in their labor provements, but it can also facilitate muddling unionactivities.23Since EPZs areimplicitly fiercely through a difficult situation without reformning competitive, distortions of wages are rare and trade policies. 17 Adherents of the view that EPZs have a nega- an outward-oriented development strategy would tive impact on economywide trade policy reform succeed. In the Dominican Republic and ]Jamaica, typically cite the Dominican Republic as a case in among other places, the idea was to augment point. But what would have happened there with- exports without necessarily reforming the out EPZs is by no means clear (EPZ exports are economywide policy orientation. now about 35 percent of total exports). Jamaica's In the other sequence, EPZs are established EPZ success is too recent to have had much policy only after manufactured exports have made con- impact even though EPZs now account for about siderable headway. EPZs are seen as one more 20 percent of Jamaica's exports. Indeed, EPZ suc- instrument to use in export-oriented industrial cess in the Caribbean and Central American coun- development. This was certainly the case in Korea triesisarecentphenomenon, brought about largely and Taiwan (China), where EPZs were used above by easy access to the U.S. market. Such access, all to attract foreign investment in selected indus- coupled with U.S. private sector development tries. Thailand has introduced EPZs late and on a assistance and World Bank operations and advice, small scale. The Philippines always saw EPZs as promises to have a positive policy effect inmostof only one part of a broader export development the region. This positive influence probably will effort. extend to the Dominican Republic as well - it has Though they are different in scale and charac- already agreed to some significant trade liberal- ter from EPZs, the special economic zones in the ization. People's Republic of China share sever,al charac- For Mexico's maquiladoras, there are conflict- teristics with EPZs that help illustrate the poten- ing views in and out of Mexico on their influence tial learning effect from enclave manufacturing. on trade policy. They may well have had a nega- As firms and local officials strive for expo;rts, they tive effect on policy during past eras of high learn what is required and how to implement it. protection, since Mexican officials could claim On a strict cost-benefit calculation, the high in- that they already had this special program to vestments in these special zones may have had expand exports, making reduced protection un- rather modest measurable yields - and leakage necessary. But Mexico's trade policies turned of inputs and illegal exports to the rest of China around dramatically in recent years, and have made the zones a worrisome experiment. maquiladora experience seems to have influenced But the zones have had an important demonstra- some of the new policies, particularly those to- tion effect on the positive effects of policy reform, ward exports. The policies, in turn, accelerated which may be extended to other parts of China. expansion of the maquiladoras. They have been a vehicle for cultural change and That EPZ successes have had a significant posi- outside influence as well. On a greatly reduced tive impact on trade policy is plausible and fairly scale, something like this can happen with EPZs in persuasive in the case of certain Asian economies, a small economy. especially Malaysia, Sri Lanka, and Taiwan (China) EPZs should be evaluated not only by their (see boxes A.1-A.3 in the appendix). In other Asian static contribution to foreign exchange earnings economies, including Korea (see box A.4), EPZs' and employment but also by their dynamic contri- export share is 3 percent at most, so a strong bution to continuing policy reforms. The adminis- impact on trade policy would hardly be expected. trative capability and industrial skills acquired, It is also noteworthy that several of the successful and the demonstration of the feasibility of an economies in Asia have chosen the EPZ as a policy outward-oriented development strategy, can give instrument not so much to get exports started as to an economy confidence to extend an equtivalent accelerate and diversify manufactured export policy regime to exporters outside the E1PZ. Fur- growth. thermore, increased foreign exchange earnings As that observation suggests, EPZs tend to be and employment through successful EPZ opera- established at two quite different stages in the tion can provide an impetus for import liberaliza- development of manufactured exports. In some tion and deregulation in the domestic market. economies, EPZs are created early in the develop- Therefore, the EPZ may play an importan t role in ment process to initiate entry into the world mar- the dynamic sequencing of policyreformsi.n some ket, based mainly on foreign direct investment. In developing economies. The importance of the EPZ Malaysia and Sri Lanka the country's leadership as a policy instrument can be expected todirminish was already eager to be convinced that this part of over time, however, as an economy uses other 18 instruments more extensively and as it moves not be an incentive and may well imply a net closer to economywide free trade regimes and transfer from the host economy treasury to the minimally regulated market mechanisms, though home economy treasury. However, some capital- its value as an industrial estate may remain. exporting economies have bilateral tax-sparing agreements specifying that any taxes spared or Discrimirnation and distortions exempted in the host economy will be treated in the home economy as if they had been paid in the Regulatory control is extensive in more than a few host economy; in this case, tax holiday benefits do developing economies, to the point where some accrue to the firm. firms and economic activities are discriminated To the extent that host governments provide against and incentives are often distorted. Creat- special tax incentives to investors in EPZs, they ing an EF'Z moves export manufacturing out of discriminate against firms outside thezones. Such this regulatory environrnent and into a business discrimination may be justified for a limited pe- setting nearly free of such effects. Compared with riod during an economy's early export develop- firms outside, EPZ firrns enjoy special advan- ment. The incentives may attract foreign invest- tages, such as less regulation and red tape, duty- ment and collaborative business ventures that free imports for use in export production, and would reject alternative locations. Any loss of sometimes better tax incentives. But firms in the revenue to the treasury would have to be weighed zone generally have to export 100 percent or close against the benefits from exports and from foreign to 100 percent of their output, and most local investment in terms of outward supply response, import-substitution firms have advantages over employment, and foreign exchange. However, it all exporters, even those in EPZs, in terms of is difficult to convince developing economies not positive effective protection rates for their prod- to compete with each other in giving excessive tax ucts. The EPZ tries to put its firms on an equal relief to foreign investors. footing with international competitors who enjoy free trade status in a goad business environment Backward links with little regulation. T'hus, local firms are dis- criminated against not by the existence of the EPZ Except in rather advanced developing economies but by the distortions and excessive regulation in that have succeeded in their outward-oriented the local economy. Local exporters outside the strategies, such as Korea and Taiwan (China), EPZs need free trade treatment and a liberal regu- significant backward links from exports rarely latory environment too, and the sooner the better. develop in EPZs.?7 An enclave is typically necessary to insulate Tax incentives and foreign direct investment EPZ firms fromhigh costs, poor quality materials, and the defects of the poor economywide policy Besides duty-free and restriction-free imports of environment. The East Asian economies gradu- equipment and inputs, foreign firms in EPZs typi- ally developed backward links as they extended cally are allowed unresl:ricted repatriation of their equal-footing policies to firms outside EPZs and capital and profits and the right to keep and developed the capacity to produce competitive manage foreign currency. In addition, developing indirect export items. They achieved this by at- econom:ies generally compete for investors by tracting investment in world-class plants at inter- trying to attract them with tax holidays.25 nationally competitive scale to make intermediate Diffe-ences among tax packages have only a goods. A number of developing economnies pro- small influence on foreign investment in EPZs, vide the same incentives and rewards to suppliers however. Practical corcerns, such as the general of inputs to EPZs as they extend to direct export- businessenvironment, .havegreater impact.?6What ers. These suppliers are indirect exporters, and foreign investors are mainly looking for are pre- developing these links is one of the reasons why dictable low taxes and no unreasonable demands parallel or follow-up policy measures to support by the tax authorities. The practical impact of tax free trade status for indirect exporters, both inside breaks clepends on tax laws in the investor's home and outside EPZs, are so important.28 By extend- country. Tax authorities often grant credits for ing an EPZ-like policy regime to indirect export- taxes that firms pay abroad, so reducing the tax ers and facilitating their supplying of EPZs, Ma- rate below the rate in the firm's home country will laysia is attracting East Asian and Jeapanese firms 19 into component industries and creating signifi- early stage of a country's development is through cant backward links from its EPZ exports. By on-the-job training and learning-by-doing - not contrast, there have been almost no backward at training centers, in formal courses, or from links from the Dominican Republic's EPZ exports, written materials. A study on the Dominican Re- in part because of the government's failure to public EPZs confirms that the EPZs contribute implement equal-footing export policies outside significantly to workers' technical prodtuction and the EPZs or to develop a strategy to foster back- factory management skills even though the acqui- ward links.29 sition of broader management capabi'lily or mar- keting skills is very slow (Rhee, Katterbach, and Transfer of technology and skills White 1990). Technicians and managers who have acquired the ability to compete in the world mar- In a relatively simple industry with no propri- ket can carry this expertise to the rest of the etary technology, such as garments and footwear, economy.3' To foster such mobility and make it technologytransfertakesplace:readilyboth inside more productive, the environment for businesses and outside EPZs. The transfer is from foreign outside of EPZs must be rationalized as well, technicians and managers working together on through deregulation and import liberalization factory floors, from foreign buyers to local firms, (for healthy competition) and industriaLI restruc- and through consultants, movement of employ- turing (for efficient production). When the busi- ees, visits to plants abroad, and so forth. But in ness environment outside the zones is riot attrac- industries such as electronic components, with tive, technology transfer effects tend. not to be internationally challenging, fast-changing, and frui tful or to contribute much to the local economy. largely proprietary technology, transfer of tech- nology to developing econornies is resisted by Environmental effects established firms. In any case, firms in most devel- oping economies are not capable of mounting a EPZs rarely house industries that are responsible competitive challenge without a lot of help. In for serious air or water pollution, and there is no industries such as these, there is general evidence that firms in EPZs are exempted from agreement that the direct transfer of product national environmental regulations. Hiowever, and processtechnologyfrom:EPZshasbeenvery electronics and certain other activities, such as small. furmiture making, use chemicals that pose envi- Firms in EPZs may transfer some technology ronmental hazards if not disposed of properly. and give technical assistance to local suppliers as Operating such activities in industrial estates they develop backward links. For example, Ma- makes environmental protection more cost-effec- laysian machine shops that worked regularly for tive for three reasons. First, there are scale econo- semiconductor EPZ companies developed a wide mies in treating hazardous waste. Firnms in many range of new skills as a result (Lester 1982).3° In EPZs realize these by jointlycontracting forwaste Korea, 286 of the 525 firms outside the Masan zone disposal services, as in developed economies. Sec- that were outprocessing for firrns in the zone were ond, manufacturers in industrial estates often have themselves in electronic and electrical industries more cost-effective options for recycling or and 76 were in metals industries. Often to guaran- remarketing industrial byproducts than those tee quality, technological instruction istransferred available to isolated plants. Finally, the average to the outprocessing firms from the resident for- cost of emissions monitoring is lower in concen- eign firms (Cho 1990, pp. 30-31). However, as trated sites, such as the industrial estates of EPZs. noted, these backward links are the exception. Growing interest in cost-effective environmental The most important technology transfer effects measures in developing economies is thLus likely of EPZs occur through the movement of people to lead to greater use of industrial estates. Thus, if trained in foreign and joint venture firms in the an environmental problem exists in a particular zone and through learning by locally owned firms economy, it relates to the economy's overall poli- there. Careful micro studies haive concluded that cies and resources and not to its policies on EPZs.32 the only feasible way to acquire export skills at an 20 5 Lessons from experience and the role of the Wlorld Bank Contributions and limitations of export When successful, EPZs are likely to have a posi- processing zones tive influence on the economy's emLployment, balance of payments, and overall development. The EPZ is the least widely used duty-free instru- But an EPZ will produce these good results ment in developing economies. Exports from EPZs only if in developing economies in 1988 totaled 4 to 5 * The economy offers a policy environment percent of their manufactured exports, and the bulk that does not thwart private sector development of these EPZ exports came fromrelatively advanced - low labor costs, easy access to external mar- developing economies that had built their EPZs by kets, satisfactory business and living conditions the early 1970s. Consistent with the small size of (including political and social stability). EPZ experts relative to total trade in developing * Transport and communications, links with economies,theBankGro ap'saggregateEPZproject the outside world are well developed, and other funding a mounted to about one-fifth of one percent public utilities are adequate. of its total lending for industry from 1975 through * The EPZ manages both the policy and opera- 1990. The Bank Group's minor role in EPZ support, tional aspects well, including EPZ promotion. comparect with its support on overall trade re- * The EPZ becomes part of an integrated forms, will continue. strategy of trade and regulatory reform. That For EPZs begun when an economy was just means that the government follows up with starting tc, develop manufactured exports, the record realistic exchange rates and macroeconomic sta- is mixed; empirical evidence does not show many bility, economywide equal-footing policies to successes. Even so, when an economy lacks the broaden and deepenindustrial developmentand administrative capabililty to implement duty-ex- exports, and improvements in import policies, emptionzanddrawbacksystemseffectivelyandlacks including reduced protection and controls. the capacity to enter the world market, an EPZ may A comprehensive plan for trade infrastruc- be the most effective instrument for attracting for- ture that is oriented toward growing trade with eign direct investment for export development. the outside world is highly desirable for ensur- Indeed, an EPZ can be created considerably faster ing that EPZ estates are well served and well thana suitable economywide duty-free system. The located. For a developing economy without an EPZ's main advantage is that when it is done well, adequate policy environment or sufficient trade it provides a duty-free and restriction-free environ- infrastructure and links to world trade, an EPZ ment with rental factory buildings and adequate cannot provide the magic to induce foreign di- supporting infrastructure that can attract export- rect investment. And such an econornywouldbe oriented investment, especiallyforeign investment. ill-advised to constructan EPZ. Instead, the firms It can also have a demonstration effect as well as a in the economy should seek other forms of col- facilitating role in skill acquisition and diffusion. laboration in export activities with foreign and 21 domestic firms, such as technical and marketing ence has been excess capacity building in EPZ agreements,internationalsubcontractingarrange- industrial estates, but this has become less fre- ments, and assistance from foreign consultants. quent. Policy failures of EPZs include the tardy These forms of collaboration may be easier to formulation of required policies, an overregu- arrange because they do not require foreign firms lated and rigid business environment, ineffective to risk their equity. implementation of EPZ laws and regulations, and lack of follow-up on further trade reforms. Factors influencing success or failure Although fenced EPZs are easy to administer from a customs point of view, extreme care is Experience suggests that certain policies at the needed to locate, develop, and maneage them as macroeconomic level and policies specifically af- industrial estates. For the most part, successful fecting EPZs are important for EPZ success. On EPZs havebeen created eitherby private develop- the macroeconomic level, a realistic exchange rate ers or by Asian public agencies. The need to turn and a stable macroeconomic environment are pre- a conventional EPZ into a well-managed, well- requisites for all manufactured exports. For poli- located, well-promoted industrial esta.te or lose cies affecting firms in the EPZ, key factors are the investment makes it a risky undertaking for * A clear foreign investment policy regime public authorilies. (including the possibility of 100 percent foreign The emergence of private EPZs in such coun- ownership and guaranteed profit repatriation). tries as Costa Rica and the Dominican Republic * Restriction-free and duty-free access to im- has recently made EPZ development more attrac- ported inputs and capital goods. tive. The risks associated with EPZ estates largely * Rapid, low-cost customs clearance for im- disappear from a national point of view when ports and exports. private entrepreneurs take on the expense, risk, * A completely liberalized foreign exchange and work of locating, developing, and imanaging regime for EPZ firms' export-oriented intema- them. Private investors will not go to unpromising tional transactions. locations, so private development and manage- * Speedy responses to uncomplicated invest- ment of EPZs is a realistic option only in develop- ment applications. ing economies that offer favorable environments * Minimal regulatory control of actions and for labor-intensive manufactured exports. transactionswithintheEPZ (includingfreedomto Countries that are serious about implementing hire and fire workers at low transaction costs). EPZs ought to consider the advantages of private * Extension of free trade status to EPZ estate EPZ construction and management. I'rivate EPZ development and management. developers and managers are likely tD avoid the On the industrial estate side, key factors are types of mistakes made elsewhere and to adopt * Appropriate site selection and location, gen- prudent management practices for industrial es- erally in a major urban area, well provided with tate construction and operation, stress effective suitable low-cost labor. implementation of EPZ policies, and carry out * Transport (major port, good roads, intema- well-conceived EPZ promotion campaigns. Ac- tional airport). tive involvement of both foreign and 'local inves- * Utilities (electricity, water, sewerage, and torsinEPZ developmentand managementshould reliable telecommunications) and services (main- be encouraged. In addition, EPZ development tenance, security, banking). and management activities should have access to * Good zone administration and management duty-freeiimportsof constructionequipment, con- (including phased construction of suitable factory struction materials, transport vehicles, and the spaces for rent as well as complementary facili- like - and to foreign exchange and finance. Public ties). sector provision of good physical trade infrastruc- * Appropriate promotional efforts (see boxes ture is a necessary complement to this approach, A.1 and A.2 in the appendix). but the physical trade infrastructure should be Operational failures of EPZs most frequently part of a larger development plan, not put in place stem from poor site selection - economies with only for the EPZ. unfavorable business environments or poor trade Any developing economy considering devel- infrastructure - poor management, and inad- opmnent of an EPZ should also weigh the benefits equate promotion. Another contributing influ- of an in-bond or duty-exemption system as an 22 alternative for firms speciaHizing in exports. The tion in EPZ industrial estate development and decision to establish an EPZ should be made only management as a condition for its support. This as part of a well-articulated, integrated strategy of would encourage the necessary institutional trade and regulatory policy reforms supported by mechanisms for ensuring good location and good exchange rate and macroeconomic policy. Key management of all aspects of an EPZ. It should parts of the strategy should be parallel implemen- also help to avoid creating excess capacities in tation of economywide dut y-free import systems EPZ estates. and prograrns of import r eform and domestic For Bank financing of the construction of an deregulatiorn. EPZ industrial estate developed by the public sector, arrangements are required to ensure an Role of the 'World Bank appropriate policy regime, efficient manaLgement, and full recovery of development costs (including The Bank should continue to consider support for land rents) and operating costs. To help achieve EPZs on a case-by-case basis in developing econo- this, the Bank should make sure that experts and mies with abundant low-cost labor that are at- practitioners with proven track record[s in the tempting to enter the world market for manufac- policy and operational aspects of EPZ idevelop- tured exports. The Bank should consider only ment are given important roles in the project. economies Project components to fund and assist promotion * Where alternatives are not feasible for attract- and management of the EPZ mayalsobeessential, ing foreign direct investment and other types of along with conditions relating to promotion and collaboration to export activities. management. Equally important, the Bank needs a That of fer or can create in and around an EPZ to incorporate flexibly phased construction sched- a rather favorable business environment. ulinginto the project design and legal documents. - That offer a suitable trade infrastructure. The timing of each phase of construction should - That are expected to do a good job managing be determined by the occupancy rate and success the policy and industrial estate aspects of the EPZ. of existing facilities, demand for space by inves- * Where the EPZ can be supported as part of an tors, and progress in assessing and accepting ap- integrated srategyfor trade and regulatory reform. plications. Finally, full cost recovery also should There are many developing economies with be among the main objectives of any public entity abundant low-cost labor that lack the administra- that develops an EPZ with Bank assistance. tive and technical capabilities to implement The Bank's emphasis on economywide duty- economywide duty-free arrangements that will free import systems, as an alternative or comple- attract foreign investment in export industries. ment to EPZs, will continue: economywide duty- But only a few of them can offer the favorable free systems are to be emphasized over specific business environment and trade infrastructure EPZs. EPZs should be considered as just one in- that are critical for attracttng foreign investors to strumentwithlimitedapplicabilityamonggawider an EPZ. In these few economies, EPZs can play an set of policies for export development, import important pioneering role in initiating economies reform, and regulatory liberalization. In a variety into world markets for manufactured exports and of circumstances an efficient in-bond or duty- startinga processof policy reform. And that would exemption system may well be more appropriate. be the leading justification for Bank support to When the World Bank considers an EPZ project, it EPZs. In economies that already have substantial should ensure that the preconditions and policy and growing exports of labor-intensive manufac- orientation are in place for a successful EPZ and turedcproductstoOECDcountries,theBankshould that the entrepreneurs understand the task. The support ErZ projects in exceptional circumstances Bank should also see that each EPZ is part of a as part of a larger package of well-aimed policy coherent package and sequence of measures to measures in export development, import reform, develop manufactured exports, supported by fur- regulatory liberalization, and macroeconomic ther measures for regulatory liberalization and adjustment. Lending to private EPZ developers, macroeconomic stability. The Bank, with limited as in the 1989 loan to the Dominican Republic, can supervision capabilities and little detailed know- also be justified at this stage. how for making EPZs successful, should be very When the Bank does decide to support an EPZ, selective and cautious in supporting EPZ projects. it should strongly recommend private participa- 23 Appendix How export processing zones in developing rent, with suitable infrastructure, to help lure economies started and spread American manufacturing firms. Most were clus- tered in what amounted to over 30 industrial Conventional export processing zones combine parks. The methods of promotion developed in two older instruments - the industrial estate, Puerto Rico under the leadership of Teodoro also called the industrial park, and the free zone or Moscoso have had a great influence on EPZs in the free trade zone. Caribbean and East Asia, and on industri-al estates from Mexico to Singapore. Industrial estates. The world's first full-fledged The first public industrial estate in developing industrial estate was set up in 1896 as a private, Asia was opened in Singapore in 1951. Malaysia's commercial venture at Trafford Park in Manches- first estate dates from 1954; by mid-1990 Malaysia ter, England. What is generally regarded as the had 139 (see box A.1). India's first industrial estate first one in the United States, the Clearing Indus- started operations in 1955; by early 1966 India had trial District in Chicago, Illinois, began operations completed 283 industrial estates and by 1979 the in 1899. An industrial zone was established by the number had reached 705. Startingaround 1960 the municipality of Naples in Italy in 1904. However, United Nations began to publish studies and hold only a modest number were established prior to conferences on industrial estates as an instrument the late 1940s. The United States took the lead and of development. by 1940 had thirty-three industrial parks. Another count showed fourteen planned industrial dis- Free trade zones. A free zone or free trade zone is tricts in 1945. a fenced or otherwise isolated physical area in or Growth became explosive in the 1950s and near a port or airport, where no customs duties are 1960s; by 1959 the United States had 452 planned collected - the zone is considered to be outside industrial districts and, by one estimate, as many the economy's tariff area. It can therefore be used as 1,000 industrial parks. These numbers grew to to store goodsin transit, to hold stocks of goods for 1,117 industrial districts in 1965 and 2,400 indus- distribution and delay paying import duties on trial parks by 1970. By comparison, the United them, or to avoid or reduce indirect taxation for a Kingdom had 55 industrial estates in 1959, France variety of other activities. Free zones in the sense had 230 industrial areas in 1963, and Canada had of areas for storing goods without paying customs 21 industrial districts in 1965. duty have existed in international trade for at least The first developing economy to make system- 2,500 years; they go back to ancient China and to atic use of publicly funded industrial parks or the Mediterranean trade of Carthage, Greece, and estates was Puerto Rico. Between 1947 and 1963, Rome. A bigger version, free ports, played a cen- Puerto Rican authorities built 480 factories for tral role as entrepots in British nineteent'h century 24 Box A.1 Malaysia's experience with export processing zones At independence in 1963 the Federation of Malaysia was a and ignored backward linkages. The government became successful primary commodity exporter with low to mod- more active in trying to develop new industries, raising eratetariffs, almostnoquantitativerestrictions,andleaders protective tariffs and increasing their dispersion. who believed in free trade ancl competition. The economy Duty exemptions were given only exceptionally until was built largely around the free ports of Singapore and reforms in the late 1980s, and as in most countries, the Penangand hadexcellentinfrastructure. Singaporebecame drawback has never worked well. An in-bond system (i- an industrial powerhouse and separated from Malaysia in censed manufactured warehouses) was introduced in 1975 1965. Meanwhile, Penang's free port status effectively van- as an alternative to EPZs, but it had less success since the ished as a result of the federation's initially mild protection policy environment was difficult to improve outside the of new industries. Seeing the manufacturing success of zones and the provisions were difficult to enforce on a Singapore and Hong Kong and of the EPZs in Taiwan decentralized basis. The system has continued to grow, (China) and wantingtosharein thebonanzain exportsand however, and today 151 firms using the in-bond system employmeent, Penang's leaders pushed hard to set up EPZs employ 75,000 people - firms in free trade zones employ in Malaysia. Thefederation promulgatedalawon free trade about 104,000. zones in 1'371 that called for zones to be developed and In 1987 the country adopted anew industrial strategyin managed by the state governments. The most successful which the successful EPZs and their import require.ments zones were developed by the states, Penang, Selangor are to serve as poles of growth. The EPZs are to beincreas- (which includes Kuala Lumpur), and Melaka (Malacca). ingly integrated with the rest of the economy, which is to One or two of the thirteen zones created have proved supplymoreoftheirinputsfromnewforeign-ownedplants unsuccesslful, and three are tco new to evaluate. The first and joint ventures. Artiffcial barriers are being disnmantled, zone (near Penang's Bayan Lepas airport) began exporting and a Korean type of export-finandng schenme with in 1972, followed quickly by several others. By 1975 eight preshipment export finance for backward-integrated sup- zones were in operation, and others soon joined them. The pliers has been established as part of the strategy. Central EPZs in Malaysia were a suc:ess from the start because of aims are to promote foreign investment and develop inter- good infr2structure and a favorable business and political nationally competitive local industries. Manufactared ex- environment, and the country rapidly emerged as a major ports, including those from EPZs, have achieved astonish- exporter of semiconductors and other electronic compo- ing growth within the new policyframework. EPZ2exports nents. have increased from 14 percent of the country's exports in For the first fifteen years (from 1972 to 1987), however, 1982 to perhaps 24 percent in 1990. Malaysia segregated the EPZs from the rest of the economy trade, above alin Asia. Hong Kongand Singapore widely separated locations. The Shainon Free are still virtual free ports, while EPZs in Malaysia Zone was set up in 1959 next to Shannon Airport were set up partly to offset Penang's loss of free in Ireland; by 1966 its employment reached nearly port status after Malaysiea became independent. 4,000. In the 1950s, Spain's Barcelona free zone, The United States now has well over 140 gen- dating from 1916, attracted assembly plants of eral-purpc,se free trade zones and a large number two major automobile firms. At first their output of special subzones. There are also free zones in at was directed mainly toward the Spanish market, least 20 European countries - Switzerland has but the zone has become increasingly export ori- the most, Spain has 22, and Yugoslavia has eight. ented and now has 160 factories with 40,000 work- Very few free zones in industrial countries are ers. In late 1958 an industrial and comnmercial free used as platforms for manufactured exports, zone was authorized by law in Barranquilla, Co- though this idea is spreading. Free zones are also lombia, though it was implemented slowly and common in other parts of the world; for example, did not achieve manufactured exports until 1970. in 1988, arnong developing economies that do not In 1961 Puerto Rico created an industrial estate for have a single EPZ oriented toward manufacturing petrochemicals based on the cracking of imported for export, Argentina had 18 free zones, Chile naptha in a free trade subzone in Guayanilla. more than a dozen, Syria six, Paraguay five, Tan- Three economies, poorer at the time than Ire- zania foui, and scores of other economnies had one land, Puerto Rico, or Spain, started building EPZs or two. in 1965 - the Dorninican Republic, India, and Taiwan (China). Construction of the first free zone Export processing zones. EPZs, combining as- was begun in the Dominican Republic, a private pects of both industrial estates and free trade zone at La Romana that was then developed by zones, made their appea:rance by or before 1965 in Gulf and Western Corporation and was officially 25 established only in 1969. India soon inaugurated provision of all necessary services. The system has the Kandla Free Trade Zone at a small port in a since spread widely in private EPZs in the Carib- backward desert area of Gujarat State. Taiwan bean and Central America. (China) was the first to use the term "export The first EPZs, especially those in Taiwan processing zone," in its Export Processing Zone (China), were widely imitated in the early 1970s. Law of January 30,1965 (see box A.2). Goals from In 1970 Mauritius passed an Export P'rocessing the start were to attract industrial investment, Zone Law creating its own distinctive arrange- promote foreign trade, create jobs, and introduce ments - firms specializing in exports would modem industrial technology.TheKaohsiung EPZ qualify for duty-free imported inputs, regardless was created on reclaimed land in the island's of their location on the island. (The idea and the leading port and began exporting in 1966. It filled name came from Taiwan (China) and the general- up quickly with investors, and by 1972 or 1973 ity of the scheme was inspired by Hong Kong and employed as many as 57,000 workers. Two more Singapore.) Another economy that stepped for- EPZs were opened in 1970 and 1971. The excellent ward quickly was the Republic of Korea, which administration of the zones by the Export Process- created the Masan Free Export Zone in :L970 and ing Zone Administration seems to have influ- had it exporting by 1971, followed by the Iri zone enced the administration of several other EPZs in in 1974-75 (see box A.3). Next came Malaysia, Asia. which launched its first zones in 1972 and followed Also influential around the world have been quickly with several others, and the Philippines, Mexico's in-bond plants known as maquiladoras. which started its Bataan EPZ in 1972, then waited The maquila program was started in 1965 through until 1979 to create the next two. Indonesia launched a simple exchange of letters between two mem- a zone in Jakarta in 1973, and India started opera- bers of Mexico's cabinet, allowing plants near the tions in its Santa Cruz Electronic Export IProcessing U.S. border to register to obtain duty-free im- Zone near Bombay in 1974, specializing in electron- ported inputs provided they exported their out- ics, including computer software. put. In 1969 Richard Campbell, entrepreneur of In the Americas the first conventional zones in the Nogales industrial park in Mexico, invented Colombia and the Dominican Republic were fol- the Shelter Plan, a system that reduced risk and lowed by others there and were joined by zones in headaches for foreign manufacturers. A simple Guatemala (1971), Honduras (1972), ancl El Salva- contract covered management of everything in dor (1973). Middle Eastern and African countries the firm's factory except the actual production that tried to create EPZs before 1975 were Jordan process, all the firm's dealings in the country, and (1973), Senegal (1974), and Liberia (1975). Box A.2 Experience of Taiwan (China) with export processing zones Taiwan (China) already had fast-growing manufactured EPZ; (3) a foundation for a science industrial park such as exports based on sound export policies when it started its the one Taiwan (China) created in 1980; and (4) a teaching first EPZ in 1965. It had created an excellent drawback and institution, promoting international cooperation. The exemption regime - known as a rebate and rebate-on- Kaohsiung EPZ was an instant success, and by late 1970, account system-in 1955 and had followed that up with four years after it shipped out its first exports, it had 162 exchange rate and macroeconomic policy reforms. As firms and about40,000 workers. Alsoby then aseccndEPZ earlyas 1956, ithadbegun tostudy Puerto Rico'sindustrial had been inaugurated, and a third was nearing comple- estates. As a result of these sound export development tion. EPZ exports never constituted much more than 8 policies, manufactured exports began to develop rapidly percent of total exports (6 percent today), and contributed after 1959-60. In-bond exports were added in the mid- some of the earliest foreign investment from developed 1960s as another option. The trade regime still had a vast economies to the development of technically demanding array of hidden and open quantitative import controls, industries. however, as well as generally high tariffs, and the regula- Taiwan (China) went on to achieve phenomena]. export tory regime was still too restrictive and complex to appeal successes, induding a remarkable diversification away to investors from developed economies. The EPZ project from garments. In the 1970s it began to liberalize its poli- in the early 1960s was developed and sold as a way to des, and in the 1980s it undertook a dramatic and sweep- attract desirable foreign investment and accelerate export ing liberalization of its imports. Confidence and know- growth. Four primary purposes of an EPZ were: (1) a show how acquired from the EPZs seem to have contributed window to attract investment in export-oriented indus- significantly to these achievements and to a convergence tries; (2) a guide for simplifying procedures outside the of the policy environment inside and outside the zones. 26 Box A.3 Korea's experience with export processing zones Korea established two EPZs in the early 1970s, Masan than the EPZs. In 1986 employmentin the EPZs, at close to (1970)andlri(1974), toattractforeigninvestmenttoexport 36,000 people, was less than 1 percent of Korea's total activities. Under an outward-oriented development strat- manufacturing employment. As of 1990 over 90 percent of egybeginningin theearlyl960s,itsexportsincreasedfrom Korea's exports were based on duty exemption or duty less than $100million in 1963 to $1 billion in 1970. Still, the drawback and 8 percent on the in-bond system, including country was not sure in the early 1970s whether it could the 3 percent from EPZs. The other 1 percent were in become a major export manufacturing economy without a special categories, such as exports for re-import. major inflow of foreign dire.t investment in selected ex- EPZ estate construction and operation costs were more port activities. Nor was it sure whether economywide than fully recovered through the contribution of EPZs and duty-free 'import systems would be effective in attracting foreign investment to Korea's export expansion in the foreign investment unless EPZs were established. Korea 1970s. The EPZs also have been effective in facilitating was committed to using all available policy instruments, local firms' interaction with foreign investors, in updating induding EPZs, and all disiposable resources (including foreign know-how, and in expanding market acacss. (The foreign loans and direct investment) for its outward-ori- majority of foreign investors in the 1970s were in the ented development strategy. EPZs.) The contribution of local resources to export expan- The two EPZs attracted foreign investors. Within two to sion has also been impressive, andfar exceeded the expec- three years, about a hundred foreign and joint venture tations of policymakers, who had underestimated the enterprises (mostly from Japan) were in operation in the production and managerial skills of Korean workers and EPZs, with exports of $175 million. Exports grew at an managers. Such skills had been acquired during the Japa- average zanual rate of 41 percent between 1975 and the nese colonial period and through U.S. military contacts mid-198Cs, close to the national export growth rate of 46 from 1945 to 1960. Because of this local export production percent per year. Total manufacturing exports from EPZs know-how and management capability (which most de- amounted to $890 million in 1985, representing 2.9 percent veloping economies lack), Korea was able to rely mainly of Korea's total manufacturing exports. The low share of on foreign trading companies for external market links EPZ exports in total Korean exports indicates that parallel and foreign loans for financial resources. This helped it instruments have been equally effective. Indeed, most of become adominant competitor in theinternationalmarket Korea's exports have come from industrial estates other for light manufactured exports in the 1960s and 1970s. Setbacks and disappointments in many of these EPZ exports in leading economies and zones. programs in the 1970s dic not prevent others from Table A.3 gives the names or locations of indi- beinglaunchedin Jamaica (1976),Nicaragua (1976), vidual zones and their employment, the number Costa Rica (1977), Sri Lanka (1978; see box A.4), of firms or plants, and the dates when the zones Bangladesh (1980), Thailand (1981), Cyprus (1982), were established. and Pakistan (1983). EPZs were also started in high-income economies in the United Arab Emir- New zones under development. EPZs are now ates at Dubai (1979) and in the Bahamas (1980). under development in several economies not More recently EPZs have been created in Brazil, shown in the tables, such as Bolivia, Cameroon, Bulgaria, Kenya, St. Lucia, Togo, and Trinidad and Turkey, and are planned in others, for ex- and Tobago. ample, Madagascar. The new zone in Togo is the most promising in Sub-Saharan Africa. Fenced zones worldwide Employment, number, and size of fenced zones. Table A.[ summarizes recent information on the There are now about eighty-six fenced zones in number of EPZs and their employment for con- twenty-seven economies. EmploymLent totaled ventional fenced zones in developing economies 530,000 in 1990, compared to about 374,000 in 1986 in each of the World Bank's four geographical and 220,000 for the zones that existed in 1978. The regions. The table does not count intended EPZs econornies with the largest employment in EPZs that did not attract manufacturing for export, are the Dominican Republic, Malaysia, and Tai- including zones in such economies as Ecuador, wan (China), followed by Sri Lanka. Seven of the Western Samoa, and Zaire, nor zones that have eight leaders are in Asia. ceased to function such as Las Mercedes in Nica- The six largest individual EPZs in developing ragua; o1her areasexcluded because of the narrow economies have over 30,000 workers each. Two definition used here are listed in the note to the are in the Dominican Republic and the rest are in table. Table A.2 gives information on the value of Asia, one each in Indonesia, Malaysia, Sri Lanka, 27 and Taiwan (China)."' The other eighty fenced America, about 1,500. In the Bank's European and zones average nearly4,000 workers each.Those in Middle Eastern region the average is less than Asia, minus the four biggest, average about 7,500; 1,000, and zones in Sub-Saharan Africa average those in the Caribbean, minus the two biggest, fewer than 500. about 3,000; and those in Central and South Box A.4 Sri Lanka's experience with export processing zones Up to the 1950s open trade policies helped Sri Lanka rarily concentrated activity there, attracting firms with become one of the highest-income economies in Asia. But larger-scale operations from Hong Kong and elsewhere in then the country shifted to inward-looking import-substi- East Asia that were escaping quotas in their home econo- tution policies and constructed a semi-socialist economy mies. These firms lured local skilled cutters and other with a state-dominated industrial sector, pervasive garment workers away from Sri Lankan firms. Flowever, nontariff barriers, and high tariffs. Living standards fell as as Sri Lanka developed other duty-free regimes - first a exports decined. In 1977 a new government, seeldng to fixed drawback, then an in-bond system for garments - emulate successes in East and Southeast Asia, began a firms spread outside the EPZ; today, most of the country's series of reforms designed to reduce the dominance of the garment exports originate outside the zone. The success of public sector and shift the economy to a mixed market these manufactured exports was a major factcr influenc- system with outward-looking policies and an emphasis on ing the import reform in the 1980s that brought tariffs to manufactured exports. modest levels and eliminated quantitative import restric- Onekeymovein theinitial sequence of reforms was the tions. Active efforts were also made to further improve creation of the Katunayake zone in 1978. The new EPZ export incentives and policies. A second EPZ was estab- quicklyprovedasuccessin attractingfirmsin simple, light lishedin 1984, and today the two EPZs employ over 56,000 manufacturing, principally garments. A widely scattered people and supply about 20 percent of the country's ex- garment industry had already begun exporting on a small ports. scale, and the creation of the zone near the airport tempo- 28 Table A.1 Employment in export processing zones by region and economy, 1990 Employment Number of EPZs 1990 Region and economy in operation 1990 Starnberg Institute Asia Bangladesh 1 9,061 7,000 (early 1991) India 6 20,750 30,000 (end of 1989) Indonesia 3 50,000 Korea, Republic of 2 23,224 20,300 Malaysia 12 104,000 98,900 (1989) Philippines 4 34,609 35,400 Sri Lank