FZW talks to Dr Jayant Menon about the status and potential of special economic zones (SEZs) and free trade in Southeast Asia

In your opinion, which sectors have the strongest outlook in SEZs in Southeast Asia?

At the moment, the electronics and automotive sectors are very important.  When you look at most countries in the ASEAN region, you see the electronics sector having a strong presence in SEZs.  The automotive parts and assembly can also be found in SEZs in many countries in the region, while Thailand is a major hub regionally.

Your report cites a figure of 3% to 9% of intermediate inputs in SEZs worldwide coming from the domestic market.  How can SEZs better incentivise the development of backward linkages, starting at the time of incorporation?

I think it is important that we look at this in terms of an ongoing process.  Some economies are at the infancy stage of development with this model.  We need to recognise that these things are time-bound and, if you’d like, dependent upon the initial conditions.  There are structural dynamics to overcome in building those backward linkages.  In Cambodia, for instance, a big constraint is the availability of skilled labour, combined with the very high cost of electricity.

The construction of parts and components is highly electricity-intensive, whereas assembly is labour-intensive.  So with the current cost of electricity, this is a major deterrent to producing parts rather than just assembling parts which are imported.

Across the board, the part that seems to be critical is the lack of domestic skill of the right quality.  For example, Malaysia for years now has been trying to upgrade or move up the production chain to higher value-added activities.  They’ve had some success, but they’ve been limited by the lack of appropriate skills.  This has been a factor in many countries.

Special economic zones tend to use their fiscal incentives as a main point in their online messages to investors, yet you note that they are usually only a marginal consideration.  What preconditions do investors really want to see when considering investing in an SEZ?

Yes, firstly, I think these incentives matter only at the margins if other factors are present.  Once those factors are met these incentives can help countries compete for extra investment here and there.  Apart from local skills, cost of electricity and other inputs are important, but the most important factor is the investment environment and overall political climate.  Investors always seek stability and security for their investments.  Some countries go so far as to guarantee the security of investments in their constitutions.  For example, they state in their laws that repatriation of profits will be freely available.

Also, macroeconomic stability within the country – you don’t want episodes of hyperinflation, and the destruction that that causes, to affect your operations.  So political stability and governance issues combine to create the kind of environment that investors are looking for.

Do you think expanding free trade and investment liberalisation in the ASEAN community could lead to the creation of more SEZs in the mid-term, or would general liberalisation make SEZs less and less necessary?

It will vary by country of course.  The newest member countries deserve to have important roles to play while other reforms are being put in place, because there are still big gaps between conditions within these zones and outside the zones, not just in investment and trade policy but with many other factors as well.  As long as those conditions exist, SEZs will have a role to play.

Over time, the challenge is to make these zones less “special”, and to make the rest of the economy appear more like the conditions within the zones.  That can happen through accelerated reforms in trade and investment and other kinds of reform that countries implement.  I see this as a good thing, not as a failure of the zones but as their real success: if the conditions can spread outside the zones and into the broader national economy.