India needs to copy China's wildly successful SEZ reforms better

By Reuben Abraham

If India only reforms when under pressure, then now should be a moment for big changes: Gross domestic product contracted nearly 24% in the second quarter, more than any other large economy; tens of millions have lost jobs in the formal and informal sectors; and the country is adding over 85,000 confirmed coronavirus cases each day. There’s an obvious place for the government to start, too: fixing India’s failed special economic zones.

China, of course, pioneered the idea of testing politically difficult economic and legal reforms in a few such areas before rolling them out more widely. The experiment proved wildly successful. Shenzhen, one of the mainland’s first SEZs, grew from a population of 310,000 and a GDP of $160 million in 1981 to a population of 12.5 million, a GDP of $388 billion and per capita income in excess of $30,000 by 2019 — surely the fastest-ever increase in human prosperity.

The model is even more appealing in a messy democracy such as India, where vested interests and a risk-averse bureaucracy have stymied previous attempts at radical economic reforms. Not surprisingly, the country is home to 238 such zones.

The results have been underwhelming, however, for several reasons. For one thing, there are simply too many SEZs. Indian state capacity is already limited. Asking the government to provide even a basic suite of services in so many places is futile. (India is running into similar problems in trying to develop a multitude of “smart cities.”) China’s experiment began with just four such zones in Shenzhen, Shantou, Xiamen and Zhuhai. India should do the same.

Moreover, whereas the Shenzhen agglomeration alone sprawls across 2,000 square kilometers, all of India’s SEZs put together occupy less than 500 square kilometers. Larger zones benefit from several spillover effects: They attract clusters of businesses, encourage knowledge transfers from foreign to domestic companies, and spread employment, infrastructure and development to neighboring regions. India’s zones are too small to do the same.

Most important, the supposed “reforms” India has implemented in its SEZs have been anything but. They’ve largely centered around concessions to favored businesses — tax sops and cheap real estate — rather than a fundamental reset of India’s convoluted and restrictive rules for doing business. If low taxes were all that mattered for attracting investment, any poor country could entice global manufacturers by slashing taxes. Clearly, good governance and strong rule of law matter a great deal more to such businesses.

The government, which is reportedly mulling a $23 billion package of incentives to attract global manufacturers to India, wisely sees an opportunity. The pandemic has exposed the fragility of critical global supply chains. No country wants to concentrate risks in any one jurisdiction, especially given rising trade and geopolitical tensions between China and the West.

To lure manufacturers away from the mainland, though, India is going to have to convince them that they’ll be able to operate just as easily and efficiently as they can in China. A few big zones should be located either near deepwater ports or around large airports. They can be greenfield or brownfield sites, depending on whether the focus is on manufacturing or services. The latter could exploit underutilized public lands, such as the eastern waterfront of Mumbai. Of course, they all need to offer reliable water and power, affordable housing, and excellent transport connectivity.

Above all, these zones must provide the kind of governance and clarity that’s in short supply across the rest of India. Local administrators must be empowered to make radical changes to labor laws, for instance. Fast-track courts to resolve disputes are critical, as is eliminating most restrictions on foreign investment. The point is not just to make production cheaper, but also to create a fundamentally different atmosphere for doing business than companies would find elsewhere on the subcontinent.

Of course, success will create its own political headaches, as a few regions get richer than others. But compared to the alternative — a future in which India never embeds itself fully into global supply chains and can’t create the millions of salaried jobs its young and growing population demands — that’s a problem the government should welcome.