What Is a Special Economic Zone (SEZ)?

A special economic zone (SEZ) is an area in a country that is subject to different economic regulations than other regions within the same country. The SEZ economic regulations tend to be conducive to—and attract—foreign direct investment (FDI). FDI refers to any investment made by a firm or individual in one country into business interests located in another country.

When a country or individual conducts business in an SEZ, there are typically additional economic advantages for them, including tax incentives and the opportunity to pay lower tariffs.

Key Takeaways

  • A special economic zone (SEZ) is an area in a country that is subject to different economic regulations than other regions within the same country.
  • The economic regulations of special economic zones (SEZs) tend to be conducive to—and attract—foreign direct investment (FDI).
  • Special economic zones (SEZs) are typically created in order to facilitate rapid economic growth by leveraging tax incentives to attract foreign investment and spark technological advancement.
  • While many countries have set up special economic zones (SEZs), China has been the most successful in using SEZs to attract foreign capital.

Understanding Special Economic Zones (SEZs)

SEZs are usually created in order to facilitate rapid economic growth in certain geographic regions. This economic growth is accomplished by leveraging tax incentives as a way of attracting foreign dollars and technological advancement.

SEZs may also increase export levels for the implementing country and other countries that supply it with intermediate products. However, there is a risk that countries may abuse the system and use it to retain protectionist barriers (in the form of taxes and fees). SEZs can also create a high level of bureaucracy due to their regulatory requirements. This can have the effect of funneling money away from the system, making it less efficient.

While there are benefits for businesses, individuals, or entities operating within an SEZ, the macroeconomic and socioeconomic benefits for a country using an SEZ strategy are subject to debate.

The first SEZs appeared in the late 1950s in industrialized countries. They were designed to attract foreign investment from multinational corporations. The first was in Shannon Airport in Clare, Ireland. In the 1970s, SEZs were also established in Latin American and East Asian countries.

China

While many countries have set up SEZs, China has been the most successful in using SEZs to attract foreign capital. The first four SEZs in China were created in 1979 in the Southeastern coastal region: Shenzhen, Zhuhai and Shantou in Guangdong province, and Xiamen in Fujian province.

China added Hainan Island to its list of SEZs in 1983. The success of the original SEZs prompted the government to create 14 "open coastal cities" in 1984. These cities enjoy similar benefits as SEZs such as the power to approve investment projects, offer incentives to foreign investors and import equipment and technology tax free. Within China, the SEZs essentially act as liberal economic environments that promote innovation and advancement. The Chinese government continues to allow these areas to offer tax incentives to foreign investors as a way of further developing the infrastructure of these regions.

In the case of China, mainstream economists agree that the country's SEZs helped to liberalize the formerly traditional state. Without the SEZs, China may not have been able to successfully implement the same level of national reform.