Export Processing Zones and Industrial Linkages

In the last issue of The World Mind, I explored the fate of the African Growth and Opportunity Act (AGOA) under the Trump administration, the implications of its potential termination, and recommendations to policymakers to avoid the undoing of this trade deal that is not reciprocal, but still vital to U.S. interests in Africa.  I made the blanket statement that AGOA has inspired the development of “Export Processing Zones” (EPZ) that build-up infant industries. In this analysis, I will examine my own assumption—do EPZs necessarily bolster infant industries in all cases? What have industry analysts said about EPZs, and if they are not effective, why do they persist?


Export Processing Zones (EPZs)


While “Export Processing Zone” sounds technical, many Americans are familiar with the general concept. In 1934, Congress passed the “Foreign-Trade Zones Act” to manage the negative effects of the Smoot-Hawley Tariff Act within the U.S. In fact, the United States boasts 277 Foreign-Trade Zones (FTZ) and 500 special purpose subzones, as of 2012. The purpose of these zones is to encourage international business and economic development by having geographical locations across from U.S. ports of entry that allow products from abroad to be used in manufacturing without tariffs.


EPZs and FTZs are both types of “special economic zones,” or geographic areas where business and trade laws are different than the rest of the country.  EPZs are established in the same spirit of encouraging investment, but there are important differences between EPZs and FTZs. The World Bank contends that the main difference lies in the overall development objective. For Free Trade Zones, the objective is to “support trade” in a general sense. Export Processing Zones, as the name indicates, are established to encourage exports, namely in the manufacturing sector. For this reason, EPZs are most prevalent in developing countries because they “attract export-oriented foreign direct investment” meant to build up “infant industries.” The concept of infant industries stems from Alexander Hamilton in 1791 when he argued for government protection of certain potentially competitive U.S. industries from British competition. There is a wide literature on infant industries and the assumptions of the economic system within which they operate. For my purpose of examining export processing zones, I will highlight two applicable parameters of this theory.


Diversion from the Infant Industry Argument  


First, the infant industry argument operates under the assumption that the industry being protected will eventually be competitive in the long-run after its initial period of protection.  For this to be achieved, the industry must rise to a certain scale of production to compete in the global market. In the case of AGOA, exports to the U.S. are able to enter without paying tariffs, like other foreign products.  Therefore, the scale these products must achieve is less (since the marginal cost for these products can be higher) than a country without AGOA. However, since AGOA allows for tariff-free entry into the United States, in some instances already fully scaled multinational corporations (MNCs) invest in Export Processing Zones in Africa by establishing new branches so the products they export from those branches can enter the U.S. market tariff-free. While there’s nothing overtly wrong with this business strategy, it undermines the infant industry framework.


In these scenarios, wealth is being created for the local economy with new foreign direct investment, but the economic surplus that results from research and design, innovation, education, and other spillovers that should characterize booming industries under an infant industry framework, is captured outside AGOA countries. In these cases, even if the industry becomes relatively competitive in the AGOA beneficiary country, the investments being made are not for the long-term.


A 2012 study by Lorenzo Rotunno, Pierre-Louis Vezina, and Zheng Wang argues that “African success” in increasing exports from the continent is attributed to “quota-hopping Chinese firms”. They also found, as theory predicts, that African countries “imported quasi-finished products with little assembly work left to do.” This trend is especially harmful in textiles, a sector that many labor-abundant African countries could benefit from. The expiration of the Multi-Fibre Agreement in 2005, which imposed quotas on the volume of textiles permitted from developing countries to developed, further encouraged multinational firms to re-route through Africa. However redirecting trade through Africa to gain tariff-free U.S. entry can occur in any sector; regulations by African governments and international partners can incite more local investment by these companies.


The infant industry argument also suggests that governments should protect industries that inadvertently bolster other sectors beyond the one being protected. However investments are often made in industries that do not necessarily have linkages to other parts of the domestic economy. For example, by investing in the clothing sector, investments are also being made in the industries that collect raw materials, transport them to the production location, and design new technologies or strategies of increasing productivity.  However, if these linkages are located outside the country, the protection the government is undertaking through the establishment of EPZs (including tax breaks for companies, low labor standards, subsidies, and other incentives) may not result in higher levels of economic development. Howard Stein writes about the regional differences between export processing zones in Asia versus Africa, arguing, “Most zones in Africa have remained rather small, with few linkages to the local economy and small foreign-exchange earnings.” Not only are African countries missing an opportunity for growth, but the incentives aforementioned are costly to local governments. This funding could be channeled elsewhere to ensure linkages, especially if the surplus from transactions in EPZs is not being captured in the local economy.


Beyond these two possible violations of the infant industry argument’s assumptions, the nature of EPZs themselves should be considered to determine how they will affect a country’s long-term economic development and growth.


Criticisms of EPZs in AGOA Beneficiaries


EPZs have drawn many criticisms, the most prominent of which come from  labor rights and deregulation advocates. In a comparative study between EPZs in Asia and Africa, Stein found that “[m]onthly wages for an unskilled textile industry machine operator were less than one third the equivalent wage in Mauritius, half of that in China, and 60 percent of the average wage in India.” In the event of unfair wages, workers in EPZs may be less likely to organize themselves. Unemployment in many AGOA-benefitting countries is high, so workers who organize are able to easily be replaced.  In some countries, such as Togo, hiring and firing laws are different in EPZs. Some multinational companies also strategically ensure that workers are from different countries and regions, so that there is no commonly spoken language between them. This method “divide and rule,” is described in the account of Ramatex, a Malaysian company operating in Namibia.


EPZs are also criticized because of the deregulation that invites foreign investment into the AGOA benefitting country. The “race to the bottom” has become a widely-used scholarly term, as it describes the competition between lesser-developed countries for foreign direct investment conducted through deregulation. As the name would predict, sometimes the country worsens certain measures of its economic development by allowing higher levels of environmental degradation, tax breaks and credits for industries, donation of government facilities for production, and other incentives.


EPZs as a Growth Mechanism


EPZs, especially within AGOA-benefitting countries, have the potential to bolster economic development and truly build up infant industries. While my initial assertion in the last World Mind issue that EPZs build up infant industries in AGOA beneficiary countries was not necessarily wrong, it was generalized. In economic development—especially within an African framework and the diverse political economy of the continent—we should strive towards specificity, not generality, especially when making policy recommendations.


EPZs have great potential to encourage economic growth.  When companies invest in local people, EPZs can encourage growth in the education sector. Local governments can also find alternative ways to encourage long-term growth in emerging sectors, even while allowing for incentives such as lower taxes. Establishing EPZs that help develop linkages to the local economy, respect local laws, and encourage long-term investment is difficult, but the benefits of well-governed EPZs can help AGOA-benefitting countries become even more competitive in U.S. markets in the long term.


About Deborah Carey

Deborah is the Secretary for the World Mind, as well as the Contributing Editor for International Development, Sustainability, and Public Health Section. She is a senior in the BA/MA program for International Economic Relations.