Discussions

Industrial Development Zones in South Africa

Industrial Development Zones in South Africa

14 Apr 2010

Sean Woolfrey, a tralac Researcher, discusses Industrial Development Zones in South Africa.

Perhaps somewhat surprisingly, the South African government’s Industrial Policy Action Plan (IPAP) released earlier this year made almost no mention of any policies or measures relating to the country’s use of industrial development zones (IDZs). The IPAP was in fact silent over whether any adjustments or improvements to the country’s IDZ model might serve to enhance the industrialisation process. Now media reports (see article) are suggesting that a Department of Trade and Industry (DTI) review of IDZ policy has prompted discussion over whether aspects of the IDZ model need to be adapted to improve the effectiveness of the zones. The DTI has reportedly indicated that current IDZ policies do not offer sufficient legislative support and that a tighter regulatory framework is needed. The possibility of providing additional incentives is also likely to be explored.

An IDZ is one form of what are known as special economic zones (SEZs). SEZs are designated geographical areas typically situated near ports or airports. Special incentive and regulatory regimes are used to encourage firms (especially foreign firms) to locate their operations in these areas. The benefits offered to firms for doing so generally include tax reductions or exemptions, duty free imports of capital goods and inputs, an absence of restrictions on repatriated capital and profits, exemption from foreign exchange controls and streamlined customs and administrative procedures amongst others. Other forms of SEZs include export processing zones (EPZs), free ports, enterprise zones and technology parks.

According to a 2008 World Bank report on SEZs , use of these zones and especially that of EPZs has grown significantly over the last couple of decades, especially in developing countries. In 1975 there were only 79 zones in 25 (mostly industrialised) countries around the world, but by 2008 there were approximately 2300 zones in 119 developing and transition economies, mostly in Asia, the Pacific region and the Americas. Furthermore, these zones employ around 40 million workers and account for somewhere in the region of US$200 billion per year in gross exports.

There are a number of reasons why SEZs have proved so attractive to developing countries over the last couple of decades.

  • Firstly, in many countries they have been used to support wider economic restructuring by increasing and diversifying exports without having to dismantle protective trade barriers. These countries have managed to increase the competitiveness of firms located in these zones by reducing business entry and operating costs, which in turn has led to a better export performance. The rest of their economies, meanwhile, have still benefited from trade protection.
  • Secondly, SEZs have been used as demonstration laboratories to test the effectiveness of policies and measures which would have been too risky to apply to the entire economy.
  • A third role SEZs have played in developing countries is as pressure valves for growing unemployment. Industries located in SEZs have tended to be highly labour intensive and this, allied with the occasional use of more relaxed labour regulations, has meant that SEZs have been significant job creators in many developing countries. SEZs have also been used to develop regions that were previously underdeveloped, but which nevertheless had significant economic potential. In addition SEZs have provided many governments with focal points for infrastructure development, which in turn has brought about the benefits associated with agglomeration economies, as related firms have concentrated their operations in specific locations.
  • Finally, SEZs have played an important role in attracting foreign direct investment (FDI). FDI is seen as particularly crucial for developing countries due to the role it plays in facilitating the transfer of skills, technology and management know-how to the host country.

Despite these benefits, the spread of SEZs among developing countries has been somewhat uneven with the majority being located in Asia, the Pacific region and the Americas. The SEZ model has also been criticised on a number of points. Some of the more notable criticisms of SEZs highlighted in the World Bank report are that such measures:

i) result in a reliance on low value added manufacturing activities;

ii) detract from the need for more widespread economic reform;

iii) divert government attention from more pressing issues;

iv) result in the exploitation of workers and iv) contribute to environmental degradation.

The evidence surveyed in the report suggests that the record on SEZ use in developing countries is mixed. The impact of SEZs on direct employment has been marginal overall, although in some countries it has been significant. FDI inflows and skills and technology upgrading is harder to assess due to a lack of data, but there is evidence that these consequences of SEZs have been significant in a number of countries, especially in East Asia. Overall, the most successful zones have tended to be those that were incorporated into wider economic restructuring efforts and which have been well integrated into their host economy. These successes have tended to be found mostly in East Asia and Latin America.

South Africa adopted the IDZ model in the late 1990s, but the process of getting individual IDZs up and running has been a slow one. There are currently five IDZs in the country, situated at Mafikeng, OR Tambo International Airport, Richards Bay, East London and Coega. Only the latter two are fully operational however. These IDZs are adaptations of the EPZ model and offer investors subsidised infrastructure, simplified customs procedures, direct links to international ports of entry, duty-free importation of production-related raw materials and inputs and VAT exemptions under specific conditions for supplies procured in South Africa amongst other benefits

Although the two operational IDZs have been reported as already having realised an impressive return on investment, South Africa’s IDZ approach has been criticised for not offering sufficient incentives to attract FDI. Another issue is that of labour regulations in the IDZs. The cost of hiring and firing in South Africa has long been viewed as prohibitive for foreign companies wishing to invest in the country, and business groups and opposition politicians have called for more relaxed labour laws for IDZs to be instituted as part of the incentive package for firms investing in these zones. Labour unions have strongly resisted these proposals, claiming that such a move would lead to the exploitation of workers in the zones. They also point out that real wages in South Africa are not particularly high anyway. Although this is undoubtedly a sensitive issue, the lack of any labour incentives is possibly hampering job creation in the IDZs, which have had only limited success on this front.

While it may still be too early to assess the overall impact of the IDZ model in South Africa, there appears to be a general feeling that while the performance of the zones thus far has not been poor, it can be improved, and that with a few tweaks, the IDZ model could play an important role in South Africa’s efforts to revitalise its manufacturing sector.

A United Nations Industrial Development Organisation report released in 2009 highlights the role SEZs can play in developing countries. The report states that the key issue for slow-growing middle income countries such as South Africa is increasing product sophistication in manufacturing. To do so it is necessary to boost knowledge, skills, technology and innovation. SEZs can assist in increasing these factors by encouraging the entry and exit of firms, which bring with them new ideas, best practices and technology, and by bringing about the beneficial agglomeration effects of industrial clustering. Importantly, SEZs help local firms to develop the capacity to package technical, marketing and managerial knowledge, to access international distribution channels and to build international reputations through working with foreign firms located in the zones.

For these reasons South Africa’s IDZ model should seek to emulate those SEZs around the world which have proved successful in achieving the aims of their respective host governments. In particular, efforts should be made to ensure that South Africa’s IDZs lead to significant job creation and an increase in manufacturing sophistication, two areas which have been shown to be vital in achieving sustainable, broad-based and inclusive industrial development. Ensuring these results however, might mean the government has to make some difficult decisions, such as increasing investments and incentives, allowing some relaxation of the more onerous aspects of labour legislation in the zones or adapting the IDZs into fully fledged EPZs. Although the country’s IDZs may continue to realize a positive return on investment even in the absence of significant reform, if these issues are not addressed the performance of the IDZs is likely to remain sub-optimal.

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