Special Economic Zones in Fragile Situations – a useful policy tool?

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Africa has witnessed impressive growth rates over the past decade. The continent has also become the world’s fastest-growing region for foreign direct investment (FDI). While global FDI fell by 16 per cent in 2014, foreign investment to Africa remained stable at US $54 billion. Maintaining the continent-wide level of investment is all the more remarkable, as North Africa experienced a 15 per cent decline that was offset by Sub-Saharan Africa, notably thanks to significant FDI increases in Central and East Africa.

In general, trends in FDI flows tend to reflect the level of confidence investors have in political and economic conditions within countries. Within limits, it can therefore serve as a barometer of a country’s perceived stability, both in political, economic and social terms, and to what extent it is believed that governments and investors have the capacity to manage potential risks. The surge in violent conflict in West Africa and the Ebola outbreak exposed the capacity weaknesses of several states to effectively confront these challenges, and contributed to a decline in the sub-region’s foreign investments of 10 per cent in 2014. 

The prevalence of peace and stability is, therefore, a key driver for investment and economic growth. The concentration of FDI inflows in a small number of countries – in 2014, the top five recipients received about as much FDI as the remaining 49 countries together – is testament to the selectivity and rationale of investors. Infrastructure and the regulatory environment are often cited as main challenges in this regard.

In view of these challenges, African policy-makers are increasingly set on solutions that hold the promise to address these challenges. In this context, the establishment of Special Economic Zones (SEZs) is gaining increasing attention and consideration across the continent as a policy tool, notably in countries facing fragile situations. The promise of a separate set of rules in a demarcated geographic area is particularly appealing for countries with big infrastructure deficits and a complex policy arena where progress on the business environment is slow.

However, setting up such zones is a complex endeavour and Africa’s own experience has shown the risks and costs of failure – even in rather stable environments. It is therefore timely to assess the opportunities and risks associated with this approach and analyze to what extent and under which conditions SEZs can live up to their promise and become a catalyst for private sector development and foreign investment in these environments.

The report contrasts the theory of developing SEZs with evidence from existing experience (more often than not of unfulfilled promises), identifying problems of weak governance and instability as particular constraints. Seeing as though issues of institutional capacity and volatility are characteristic of fragile situations, implementing an SEZ programme is all the more challenging in those contexts. The risks of pursuing an SEZ approach for the wrong reasons, based on political rather than economic considerations, is more prevalent in fragile situations where policymakers under enormous pressure to show quick results. However, the resulting risk that SEZs thus disappoint raised expectations in the population and damage investor confidence is often overlooked.

The main lessons emanating from this study are that i) SEZs require a minimum level of state capacity, ii) SEZ policy design and implementation is a lengthy and difficult process, iii) there is an increased threat that SEZs in fragile situations may fall captive to vested interests, iv) meaningful private sector participation is even more important in fragile situations.

Building on its comparative advantage as a “trusted advisor and honest broker”, the study urges the African Development Bank to systematically advise and support governments, notably when in fragile situations, as to whether or not, and how, to establish SEZs. This topic should be high on our agenda for policy dialogue with concerned governments, private sector and development partners from the initial stages to avoid pitfalls from the past. SEZs can present significant opportunities to support economic growth and create jobs in fragile situations, but only if the business case is strong and the political economy supportive.