Unsustainable Logic of Promoting SEZ
The congress government with its confused power structure has been unable to push through reforms. The SEZ act of 2005 was passed, and Madam Sonia writes a letter asking the government to go slow, and promptly the government goes slow. Im not complaining though, I’m happy with this structure. I’m even more delighted that the establishment of SEZ has stopped. Yes, I’m delighted, though I’m not a leftist/socialist.
First, its important to understand what an SEZ implies, and the special feature. I’ve culled the most important facilities from this site:
1) A designated duty free enclave to be treated as a foreign territory for trade operations, duties and tariffs.
2) The usual plethora of tax exemption
Essentially the idea is that this will promote export and earn the country foreign exchange. For any enterprise operating in an SEZ, there are two distinct advantages:
1) Bypasses governmental red-tape and machinery
2) Tax Exemptions.
I am a fan of neither advantage an SEZ bestows on companies operating out of them. First the point is the government has to reform its administrative machinery. The benefit of an efficient government machinery should be bestowed all constituents of the country, rather than just a few who operate within the SEZ. Industrialists and the public alike have been asking for reforms in the government machinery for years now, and the government has now stated that only those firms which are export oriented will avail this benefit. This discrimination is unnecessary, and detrimental to long term growth.
Secondly I am not a huge fan of tax exemptions for industries. It is flawed logic to believe that tax exemptions will attract investment. FDI flows into countries based on the ease of doing business and the competitive advantages that country offers for the investor. In a scenario where various countries compete for FDI investment, almost all the countries can offer tax exemptions, and in this game, tax rates will continue to spiral downwards. Arracting investments based on tax exemptions are a zero-sum game for the host country. A foreign investor, chooses destinations based on comparative advantage that it offers them and the risk of investing in that country. The government rather than aiming to reduce the risk it creates has chosen the option of reducing the risk in selective areas, that is within the SEZ. And it is another stupid belief in this country that lower tax rates promote growth. If that is the case, then the least possible tax rate should lead to huge investment and phenomenal growth, and any country wishing to grow can just adopt a 0% tax rate, but that isn’t the case. Empirical studies have shown that investors are more worried about perceptions of risk. The government in India creates huge risk for a foreign investor, with its inefficient machinery and unstable policies. If it was to lower this perception and has stable tax rates, investment will automatically flow into the country and it need not bother establishing SEZs. It is imperative to understand that tax is important for a country to guarantee essential rights like the right to hold private property, external defence and internal security. Lowering tax revenue might reduce the states capacity to carry out these essential functions. Governments should understand this and have stable and reasonable levels of tax.
One of the biggest advantages investors notice in SEZ according to this link, is the power bestowed upon them to formulate their own laws, on areas like environment and labour. Labour laws need to be improved no doubt, but the laws in existence regarding the environment have been formulated to deal with industries, and control pollution. It doesn’t make sense to allow the biggest polluters to bypass the law. Lets assume that an SEZ, has reformed labour laws, like what needs to be done in the rest of India. What will happen is that the producers inside an SEZ have an advantage vis-a-vis those outside SEZs. Now, under the guise of being exporters, companies which are actually domestically oriented have an incentive to relocate inside SEZ to avail of the lax labour laws. They can of course sell their products in the domestic market as long as they pay the taxes. So SEZs in actuality might just encourage the relocating of investment from outside SEZ to within them, rather than adding substantial capacity.
But China?
It is important to understand that china is a communist country, and to allow FDI, would require fundamental changes in its system. China when it decided to adopt SEZ policy didn’t allow
1) Private Property
2) Private firms couldn’t generate profits
3) Foreign Direct Investment
4) Restrictions on Profit Repatriation/Exports.
In such a scenario, no private investor will be willing to invest money. Being a communist country, China if it wanted to attract foreign direct investment, without the SEZ model, would have to allow all these previously banned rights to everyone in the economy. Not wanting to do so, Chinese sought the SEZ route where within the specified area, these rights were allowed. It was a necessity for the Chinese to allow SEZ. China had to adopt SEZ, but India does have alternatives. Blindly copying the Chinese policy isn’t the solution.
But SEZ promotes Clusters, like Textile/IT Clusters
True SEZ promotes clusters and enables firms to benefit from collective bargaining. But can this be promoted only through SEZs? Such clusters can be developed even outside the framework of SEZ.
For India it isn’t the case, the advantages bestowed by the SEZ should be bestowed upon everyone in the country rather than a select few. The government has used this policy to avoid tough measures and reform its administrative machinery. This policy is shying away from important questions, and can hurt long term growth. It is a short term answer to growth and unsustainable in the long term, unless the government reforms its system. Long term growth has to come from within the economy and not through exports. India has to grow on the back of the consumption capacity of its population rather than exports. For this to happen, the advantages of the SEZ, especially efficient government machinery have to be opened up to all. SEZ is a short term solution. It is like taking a painkiller to cure arthritis, it will give temporary relief, but the pain will resurface after the effects have worn off. Similarly, the SEZ can do only this much and no more, after a while, the economy will once again stall, and probably will have sluggish growth.
Vatsan,
"FDI flows into countries based on the ease of doing business and the competitive advantages that country offers for the investor."
True. I guess the tax exemptions might favour those business units in the host country rather than foreign investors.
"then the least possible tax rate should lead to huge investment and phenomenal growth"
Least possible rate keeping in view the Governments revenue would be apt. But again, it is a moot point.
"Governments should understand this and have stable and reasonable levels of tax."
Very true.
Liked your post. :)
Posted by
Alex |
1:44 PM
mams u shud join some new channel da ... business new mostly suck ... nee poona kalasiduve
nice line of thoughts :) ... govt's is not just meant to do whatz in the nations best interest ... they also gt take care of some others welfare ;) ... there are lot of personal interests @ stake ... they are not doing social service u see :D
they need to do only enuf to please ppl ... do or project the act of doing what ppl think is gud for em
Posted by
SamY |
3:13 PM
"The benefit of an efficient government machinery should be bestowed all constituents of the country, rather than just a few who operate within the SEZ. Industrialists and the public alike have been asking for reforms in the government machinery for years now, and the government has now stated that only those firms which are export oriented will avail this benefit. This discrimination is unnecessary, and detrimental to long term growth."
How Long should Industry wait??..You understand that there is a dichotomy between the economic rational and political expediency ..So SEZs may be sort of a loophole to attract Investment which may not come otherwise given the labour laws and Red Tape. And Remember, once a few SEZs become successful, that model may be replicated elsewhere and there will be pressure which may be able to overcome the political expediency. So in the long term, this policy should be beneficial and not detrimental as you suggest. Just waiting for reforms to take place is a bad gamble as per me.
"It is flawed logic to believe that tax exemptions will attract investment. FDI flows into countries based on the ease of doing business and the competitive advantages that country offers for the investor. In a scenario where various countries compete for FDI investment, almost all the countries can offer tax exemptions, and in this game, tax rates will continue to spiral downwards."
This is a very static analysis, what happens when already your neighbours are providing such concessions. Take Sri Lanka, They provide almost all the concessions plus their Red tape is nearly not as bad as ours. And they have a FTA with India. I am sure there may be similar examples from South East Asia as well.
So the basic questions is what will attract investment given such a scenario, concessions - be they removal of red tape or tax holidays and a big market. Now India already has a decent market, plus low cost skill sets to attract investment. So anyway some investment will come, still if a big push can be given , something like the current SEZ which will force all the companies to bring India into their Radar for future investment.
So my take is that without SEZ, India may have a Hindu rate of FDI...Some reforms in the form may be needed to kickstart the same.
Please do take look at the proposed investment in SEZs and the normal Investment figures for the past 5 years. Also keep in mind that, Investment has a dual role and the fundaes of Accelerator is there which can take the economy to a higher plane.
Posted by
Spiff |
3:24 PM