Processing the Export Zones

Free Economic Zones in Eastern and Central Europe

By: Dr. Sam Vaknin

Also published by United Press International (UPI)

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February 9, 2003

Ukrainian President, Leonid Kuchma, told, last week, an assembly of senior customs service officials that "it is necessary to put an end to (Ukraine's 11 free economic and 9 priority) zones (and) liquidate them completely. (They) have become semi-criminal zones, and this refers not only to the Donetsk zone. You pull the meat that Europe doesn't want to eat into these zones and sell it there without [paying] taxes".

According to UNIAN, the Ukrainian news agency, Kuchma was fuming at the mighty and unaccountable oligarchs situated in the country's eastern coal-mining center and their collaborators in the Ukrainian Security Service (SBU) and other law enforcement agencies. The zones dismally failed to attract foreign direct investment, or foster economic growth, he bitterly observed.

The International Monetary Fund (IMF) concurs as does the European Union. The future status of special economic zones is hotly contested in the accession negotiations with the Czech Republic, Poland, Hungary and Malta. Nor is the criminalization of such zones a Ukrainian deviation. Russia's Deputy Interior Minister, Vladimir Vasiliev, admitted last year that Russia's mafia now focuses its unwelcome attentions on its ubiquitous free economic zones.

Yet, the proliferation of these fiscal monstrosities - tax free, low customs, export processing, flexible labor delimited regions - is likely to continue. Even bastions of free trade make profligate use of them as do all the countries of the rich world.

According to a November 2002 report titled "Employment and social policy in respect of export processing zones" and published by the United Nations' International Labor Organization (ILO), the number of countries with export processing zones surged from 25 in 1975 to 116 last year. The number of such havens jumped to 3000 from a mere 79.

A January 2002 amendment to Estonia's value added tax law allows its fishermen to export to Russia more than $100 million worth of catch via tax free enclaves. Virtually all the countries of central, east and southeast Europe (the Balkans) either toyed with the idea, or established such zones, the first being Russia, Poland and Bulgaria.

Even hidebound and xenophobic Belarus founded in 2000 four Free Economic Zones (FEZs), located in Brest, Minsk, Gomel-Raton and Vitebsk, to, in its words, "attract foreign investment, promote high-tech manufacturing and increase economic diversification". The zones, claim the authorities, have been a success. The Brest one drew in excess of $120 million in investments and has created 5000 new jobs.

Multilateral lenders and international trade partners are unhappy. Exemptions from taxes and customs duties amount to overt export subventions. The goods thus subsidized often end up in the local market, unfairly competing with both indigenous producers and importers.

Responding to such pressures, Kyrgyzstan now requires enterprises located within the free-economic zone to pay customs and other taxes on goods they sell domestically. Both the European Union and the United States expressed extreme displeasure at the formation of Macedonia's Taiwan-financed free zone in Bunardzik in 1999.

It has since flopped and has been leased last September for 30 years to Ital Mak Furnir, an improbable German-Italian-Macedonian partnership. The only occupant of the sole building constructed in the zone by the Taiwanese is rented to the NATO mission in Macedonia - hardly a business enterprise.

The free economic zone of the Russian exclave of Kaliningrad, formed in 1992 and revamped in both 1996 and in 1997, under the new law on Free Economic Zones, shares a similar fate. Lithuania's industrial parks are not successful either. The free zone of Kukuljanovo in the industrial zone of Bakar, about 17 km from the Port of Rijeka Free Zone in Croatia, actually serves as a trans-shipment and off-shore area, rather than a classic export processing district. It is one of 13 such fiscal havens.

Tax free, customs and export processing territories - though they may enhance employment, as they did in China, for one - distort the economic decisions of investors, manufacturers, importers and exporters. Budget revenues are adversely affected. The zones attract shady "industrialists" and "financiers" who set up fronts for illicit activities, such as smuggling, unauthorized assembly of consumer goods, or piracy of intellectual piracy.

These extraterritorial hubs are major centers of money laundering, parallel imports of shoddy or counterfeit goods and forbidden re-importation of merchandise originally sold to poor, developing countries at substantial discounts, or provided as international aid.

The Ukrainian Vice-Premier Kozachenko estimated, last May, that one fifth of all meat sold in Ukraine was smuggled through the special zones, reported UkInform. Most of it is unfit for human consumption. The impoverished country lost $56 million in customs duties on these products in 2001 alone. In the meantime, the local meat industry is "choking" in the words of Yuri Melnik, Deputy State Secretary for the Ministry of Agrarian Policy.

Yet, the undermining of local production is not the only impact on oft-struggling host economies. According to the ILO, throughput from special zones accounts for 80 percent of all the merchandise exports of the Czech Republic and Hungary. But very little of this abundance trickles down:

"Legal restrictions on trade union rights in a few EPZ operating countries, the lack of enforcement of labour legislation and the absence of workers' organizations representation were among the factors noted as undermining the ability of zones to upgrade skills, improve working conditions and productivity and thereby to become more dynamic and internationally competitive platforms."

And the contribution of these zones to economic growth and subsequent prosperity? Dubious, at best. The ILO concludes:

"(There is a) lack of reliable ... statistics regarding the costs and benefits of zones. While some data exist relating to the amount of investment, exports and employment in zones, there is very little ... on the quality, cost and duration of those jobs, on the degree of skill and technology transfer and on the opportunity cost of the fiscal incentives and infrastructure costs. (We don't know) why export processing zones (EPZs) have failed to take off in some countries. While political stability and investment in the basic infrastructure in ports, airports, roads, water, sanitation and power supply are necessary conditions for EPZs, they are not sufficient on their own to attract FDI. Macroeconomic conditions such as extreme inflation and high interest rates (are important) ... Research suggests that zones are most effective when they form part of an integrated economic strategy that includes fiscal incentives, investments in infrastructure, technology and human capital, and the creation of linkages into the local economy. It is important for EPZs to upgrade their activities to higher value-added products and services (requiring a more skilled workforce) and find their niche in the international production network ... (EPZs strategies must, therefore, be) continually adapt(ed)."

The countries of east Europe and The Balkans lack the skills and experience to do so - and the money needed to hire international consultants to monitor and modify the zones' performance and characteristics. Hence the hitherto abysmal performance of these contraptions - and the emerging trend to disassemble them.

Also Read:

Economic Free Zones in Macedonia

Foreign Investments - A Dialogue

Eastward, Ho - FDI in CEE

Trade Imbalances and the Health of the Economy - a Dialogue

God's Diplomacy - International Trade

Trading from a Suitcase - The Case of Shuttle Trade

The Agenda of International Trade - Interview with Dan Horovitz

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