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After the dismantlement of special economic zones (SEZs) in Ukraine and abolition of special privileges for businesses operating on these territories, many argued about the necessity of SEZs renewal. At present, when wide-scale reforms are being drafted in our country, the subject has become even more relevant. Do we need SEZs to boost economic development in Ukraine and its specific regions? This question demands serious speculation as Ukrainian and international practices show that under different circumstances SEZs may prompt positive changes or yield negative results.
Advocates of SEZs believe that these zones, established on a temporary basis, can serve as pilots for reforms in regulatory policy, taxation and general simplification of business rules. It is easier and less risky to probe effectiveness of these reforms on a smaller territory. Moreover, there is no need to change legislation in the entire country. A good example are Chinese free ports and SEZs in Taiwan, which operate under special fiscal and regulatory terms that are later planned to be replicated across the country. Moreover, other developing countries have long used SEZs as a tool to attract direct foreign investments. To keep up, Ukraine also needs to offer special conditions to inward investors. SEZs can be established with special investors in view and tailored to meet their specific requirements. Mexico and Madagascar provide successful examples of how negotiations with a certain investor shaped business conditions of a special economic zone. Business usually views the creation of SEZs positively and favors free zones, investing in their infrastructure and creating new jobs.
The state can stimulate the development of top priority economic sectors, granting privileges to the companies working in these sectors. Ukraine has the qualified and relatively cheap human capital; creating the favorable administrative business environment will certainly make it more attractive to investors. Hence one way to realize the regional development program is to establish SEZs in geographic or industrial cluster areas. By carefully prioritizing the development tendencies in certain sectors of economy, the authorities can help revive the economy of the entire region. SEZs in Poland are successful examples of this approach, while the Persian Gulf countries present thriving and popular free zones, created at business clusters (e.g. media and the Internet).
Opponents of SEZs criticize them for several reasons. Firstly, as Ukrainian experience has revealed, many companies tend to misuse tax and customs privileges. Tax evasion and smuggling of import goods delivered a devastating blow on the country’s economy. Heavy corruption and flawed legislation open up numerous opportunities for illegal activities. Rather than bring forth positive results, SEZs may cause revenue shortfalls from tax and customs as many companies on the mainland can use these zones for illegal transactions.
Moreover, countries with SEZs face a serious danger of imposing unequal competition and pricing policy. Because some companies in export-oriented industries are granted special privileges, they can lower their prime costs. In the mean time, it is nearly impossible to stop these goods from penetrating the domestic market, discriminating manufacturers outside SEZs. This may have a very disturbing impact on both local and foreign companies, discourage investors and harm certain economic sectors or the entire economy.
The motion if special economic zones are needed to improve Ukraine’s competitiveness will be discussed at the public debate, organized by the Foundation for Effective Governance. The debate will be held in Kyiv on April 27, 2010.
Note
A special economic zone (SEZ) is a designated area that has economic regulations that are more liberal than a country’s typical economic laws. These regulations commonly include tax, customs, financial and administrative incentives. The category “SEZ” covers a broad range of more specific zone types, including free trade zones outside the state customs boundaries (there are a great number of this type in West Europe, e.g. Hamburg in Germany, Shannon in Ireland, etc.); industrial estates with special provisions for the companies working in a certain sector of economy (i.e. Laem Chabang in Thailand, specializing in heavy industry and petrochemistry); technoparks with special conditions for implementing innovation projects (such as technoparks in Malaysia and Singapore); free ports (e.g. in China) and so forth.
In the mid-1990s, following successful examples of other developing countries, Ukraine established its special economic zones and granted tax incentives and customs privileges to the companies operating within these areas. The main objective was to attract foreign investments and boost regional development through establishing a stable investment environment. By the early 2000s, the number of SEZs in Ukraine (including territories of priority development within administrative boundaries – towns, districts and regions) had exceeded several dozen. However, in 2005 the Ministry of Economy questioned the efficiency of SEZs in Ukraine and the same year all fiscal advantages in the country were abolished. The Government explained that the initial goals were not achieved, while SEZs were tainted as areas of tax and customs violations. Meanwhile, successful stories of many countries prove that SEZs may also be an effective tool to improve business climate and encourage economic development.
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