doi:10.1111/rsp3.

12030

The rationale of special economic zones (SEZs):

An Institutional approach
Konstantinos J. Hazakis
Department of Economic Sciences, Democritus University of Thrace, University Campus, Komotini, 69100, Greece,
(e-mail: kmhazaki@otenet.gr)

Abstract. Research on special economic zones (SEZs) economics has burgeoned in the last
three decades. The paper enriches the understanding of SEZ rationale from an institutionalist
methodological approach. The key argument is that the literature should examine the processes
through which cognitive, regulative and organizational traits of SEZs interact. It is argued that
the methodological gap between economic agents, institutional structures and SEZ organiza-
tions could be bridged if more light is being shed on their interaction rather on their analytical
separation. Equally important, it is claimed that the interplay of SEZ structures and SEZ
economic agents determines the success or the failure of zones.

JEL classification: B52, R10

Key words: special economic zones (SEZs), regional policy, regional development, institu-
tional economics, political economy

1 Introduction

Throughout the world, states are engaged in the process of establishing special economic zones
(SEZs) attempting to ameliorate economic competitiveness of de-industrializing or underdevel-
oped regions (Aggarwal 2006). Accordingly, research has burgeoned in the last three decades
and elaborates an ample variety of SEZ types targeting different interactions between regional
institutions, firm capabilities and regional competences.
The present paper enriches understanding of SEZs rationale from an institutionalist meth-
odological approach. The key argument is that the literature should examine the processes
through which cognitive, regulative and organizational traits of SEZs interact. It is argued that
the methodological gap between economic agents, institutional structures and SEZ organiza-
tions could be bridged if more light is shed on their interaction rather on their analytical
separation. As Amin (1999) put it when examining regional economic development, the key
challenge is to find a way of substituting traditional ties of hierarchy and dependency with links
of mutuality between economic agents and institutions. Equally important, it is claimed that the
interplay of SEZ structures and SEZ economic agents determines the success or the failure of
zones.
The paper proceeds as follows. Section 2 introduces a new conception of SEZ based on
critical dimensions which are relevant to institutionalist approach. Section 3 examines in detail
© 2014 The Author(s). Regional Science Policy and Practice © 2014 RSAI

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86 K.J. Hazakis

the pillars of institutional analysis for SEZs while Section 4 presents the fundamental institu-
tional principles for SEZ analysis. Finally, Section 5 offers concluding remarks.

2 On the definition of special economic zones (SEZs)

Despite the fact that many economists define SEZs, no consensus has been achieved in the
denomination of the concept (Schweinberger 2003). In the academic literature, too often, free
zones, export processing zones and SEZs are not clearly classified, (Farole and Kweka 2011).
Farole (2011) claims that the multiplicity of names of economic zones is the result of several
variables, including the need to differentiate among types of zones that display very real
differences in terms and function, differences in economic terminology among states, the need
to differentiate new zones from already existing competitors and the repercussions of various
translations.
Usually, research efforts do not clarify how special a free zone’s regulatory framework
should be before it can be considered as a SEZ. The definitional effort becomes even more
difficult as the SEZ model has evolved considerably in terms of policies, governance, ownership
and spatial location (OECD 2005).
According to FIAS (2008), the features incorporated in the concept of a zone include a
geographically delimited area, usually physically secured, a single management, the eligibility
of advantages based upon physical location within a SEZ, a separate customs area and stream-
lined procedures. Ahrens and Meyer-Baudeck (1995) argue in their definitional effort that SEZs
are geographically or functionally limited parts of an economy in which rules and other
institutions concerning the production and the distribution of goods and services differ from
those in the rest of the economy. Farole (2011) further suggests that any definition of a SEZ
should comprise both structural and policy features. Regarding the former he underlines the
following three traits:

1. zones are primarily delimited portions of the national territory and are defined by a specific
regulatory regime;
2. the administration of the regime demands a dedicated governance mechanism; and
3. zones are provided with a physical infrastructure supporting the activities of economic agents
operating within them.

FIAS (2008) adds three more structural characteristics, namely single management/
administration, eligibility for benefits and separate customs area procedures. On the issue of
policy features, Madani (1999), Cling and Letilly (2001) and Farole (2011), distinguish four
motives for the establishment of a SEZ:

1. attract FDI inflows;

2. serve as pressure valves to address high unemployment rates;
3. support national reform strategy; and
4. serve as experimental laboratories for the application of new economic policies.

According to our view there is a need for a broader SEZ definition which includes regulative,
normative and cognitive features, stressing that SEZs are shaped and transformed through a
complex interweaving of economic-political-social-institutional factors. The above mentioned
definitions make clear that often the question of what type of SEZ conception to apply is a matter
of methodological preferences as well as of research priorities and case study data in hand. It is
also apparent that the bulk of concepts present SEZs as a simplistic development tool providing

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The rationale of special economic zones 87

easy policy answers and useful checklists. However, as Ostrom (1986, p. 4) underlines, “no
scientific field can advance for, if the participants do not share a common understanding of key
terms”. Likewise, the present paper argues for an operationally working definition on SEZs in
order to provide a solid framework within which political economists could trace the funda-
mental elements of SEZs, facilitating better understanding of SEZs differences, similarities and
interactions. It is further suggested that a SEZ definition should be comprehensive enough to
accommodate all commonly perceived categories of SEZs, but at the same time should not be
so expansive as to be analytically useless. Further, the definition should lay the ground for a
taxonomy of SEZs based on adequate analytical reasoning revealing how SEZs’ structure and
SEZs’ economic agents interact.
In view of these considerations the paper claims that SEZs are administratively defined
territories, influencing interactions and competitive/co-operative behaviour of economic agents,
through dynamic and interrelated cognitive, normative, regulative and organizational structures,
routines, incentives and processes. Thus, it is argued that consideration of an SEZ as a static/
fixed organizational entity in all places and time is inappropriate for methodological and
analytical reasons. On the contrary, SEZs are conceptualized as dynamic entities based on a
mixture of routines, norms and processes which may extend or shrink overtime. Failure to
understand the evolutionary and path dependent nature of SEZs is likely to deny interac-
tion among structures and economic agents, leading to low competitiveness and SEZ
underperformance. The new definition is also a multidimensional one because it suggests that
many factors operating simultaneously at various organizational-interaction levels affect the
performance of SEZs economic agents. This clearly means that each time policy-makers have to
decide at what level economic agents interactions occur and to what extent SEZs cognitive
targeting is relevant in this respect. In like manner, the term facilitates understanding of how
agents behaviour is situated by structures accumulated at micro level of organization (routines),
at meso level of organization (networks) and at the macro level (institutions, social capital). All
three levels are considered vital because they enable or constrain agents’ economic behaviour.
Similarly, the definition argues that SEZ is not an exogenously given instituted framework
but it is the outcome of a socially embedded process. In particular, it incorporates in the
economic level analysis of SEZs, the awareness of the complexity of social forces within
regional productive systems. Hence, more transactions occur not in an impersonal and calcula-
tive system of autonomous agents unrestrained by social bonds but rather in the contact of social
ties variation. The strength of these ties leads to variation in levels of SEZ firms’ costs and trust.
What clearly distinguishes SEZs from other administratively agglomerations is the strong
interaction between cognitive, regulative, organizational and normative traits in a specific
economic/social environment. Economic agents located in successful SEZs are not simply
recognizing the value of SEZ regulations and incentives but share understanding of acceptable
types of economic behaviour. Evidently, part of SEZ differentiation is rested on inter-subjective
norms and fundamental targets and is supported by a collectivity of structures and economic
agents. At the normative level, SEZs are not simply the setters of the rules of the game but are
considered fundamental mechanisms for the diffusion of specific patterns of agent behaviour
that follows regulations.
In addition the definition underlines the importance of routines, norms and principles in the
operation of an SEZ. Routines, (which according to Nelson and Winter 1982 are the
organizational memory) embedded in the skills and capabilities of SEZ networks (often tacit in
nature, path dependent and cumulative) are considered important for SEZ performance. Con-
stitutive norms, (which are not simple rules to impose but important perceptions adopted
through network socialization and institutional persuasion in SEZs) provide SEZ economic
agents with capabilities and have an impact on their performance as well as on the network
identity traits (for an extensive overview of constitutive norms see Finnemore and Sikkink

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88 K.J. Hazakis

1998). Using North’s (1994), conception of shared mental models, constitutive norms exist in
the minds of economic agents, making exchanges/transactions within SEZs predictable and
simpler. Consequently, all patterns, structures, incentives and processes within SEZs, become
infused with cognitive value. Obviously, if an economic agent activity is against SEZ networks
identity, he is not only an entity not to be trusted but also an entity technically, functionally,
cognitively and morally out of the SEZ network. Likewise, legitimacy becomes easier through
economic agents’ conformity to SEZ networks principles and norms. SEZ organizational prin-
ciples are also crucial for governance structures in the sense that they reinforce shared under-
standings inherent in SEZ agent practices. Thus, SEZ firms draw on prevailing rationalized
norms/principles which are embedded in SEZ networks and are linked to specific purposes. SEZ
norms and principles are not divined but are adopted as they reciprocated among economic
agents of SEZ networks. Clearly, routines in a successful SEZ have a triple role, namely, they
reproduce problem-solving competences at micro and at network level, they are functional
channels for the accommodation of conflictual inter-firm relations and they are mechanisms for
innovation accumulation.
Based on the new concept, SEZ competitiveness is not the outcome of a linear and mono-
causal link between tax-financial incentives and firms’ capabilities, but depends equally on the
co-evolution of intangible/relational assets of SEZs territory and firm competences. Success/
failure of SEZ depends both on intra-organizational resources (embodied in competences and
routines) and extra-organizational network assets (such as relational capital and complementary
information resources). In the same manner, SEZ’s successful strategy is differentiated by its
institutional orientation and is concerned not so much with authoritative promotion of a static
regional competitive advantage of low labour cost and social dumping but it is concerned with
enforcement of a strategically favourable set of institutional, social, economic, knowledge
conditions in a regional context as well as with management of inter-firm co-operative/
conflictual relations in SEZ networks. As far as it concerns the latter, it is crucially important to
trace the fundamental qualities of SEZ networks, namely co-operation without authoritative
centralization, complexity of dynamic interactions between interconnected economic agents,
ways of inclusion/exclusion based on implicit/explicit norms and strong significance of shared
routines between SEZ network firms. Last but not least, the new SEZ term allows the capturing
of the empirical wealth of SEZs’ case studies, demonstrating that SEZs do differ in institutional
configurations, power distribution, integration to global production-knowledge systems,
resources endowments and sectoral competence even within the same country. For example,
India’s SEZ policy (Cheesman 2012) includes traditional SEZs, smaller/diversified SEZs,
export processing zones and export oriented units (EQUs). However, the fundamental trait of
efficient SEZs is related not only to embeddedness of companies in suitable networks of
inter-firm information sharing but also to institutions competent enough to provide trust, repu-
tation and co-ordination through dynamic interactions with SEZ economic agents.
What distinguishes the new SEZ concept from static views is the perception of SEZ, as an
avoider of negative bureaucratic externalities/costs for firms, as an avoider of rent seeking
behaviour stemming from bounded rationality of local vested interests, as an avoider of risks
resulting from uncertainty and economic complexity and of course as an avoider of low
innovation performance due to asset specificity and crowding out financing. The proposed term
also suggests that the legitimacy of SEZs rules, norms and patterns of behaviour are dependent
on the effectiveness of their daily reproduction. This is why rules are the subject of continual
transformation by SEZs economic agents. In a nutshell, rules and norms of SEZs provide not
only the motivation but also the means for SEZs target implementation.
Finally, it notes the importance of highest level political commitment in supporting special
economic zones operation and the necessity for inclusion of a special zone in national devel-
opmental strategy. State engagement is critical as an effective catalyst for strengthening local

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linkages within special zones. Indeed, as East Asian experience demonstrates, special zones
linked specific economic activities with regional infrastructure (ports, trade gateways) and with
national/regional master developmental planning. In Malaysia, the free zones strategy was
linked to the national industrialization programme through five year master plans and in
Singapore special zones were used as a tool of global economic integration, targeting outward
oriented growth (Hazakis 2001). Even late comers such as Vietnam, implemented strong
leadership in integrating zones in national economic strategy giving a positive signal to potential
foreign investors on the long term business policy of the state. In Mauritius, the state’s trade
policy was closely linked to the targets of a free zones programme (Farole 2011), in Kenya a free
zones strategy was part and parcel of the national export development programme and in Ghana
the deployment of a free zones strategy was closely associated with national target of rendering
the country into a regional export platform (Farole 2011). On the other hand, many African
countries (e.g., Tanzania and Nigeria) did not give enough attention to strategic planning and
positioning of special zones, undermining zones competitiveness.

3 The methodological premises of institutional analysis for special economic

zones (SEZs)

SEZs have been the subject of intense academic debates on almost every facet of their rationale,
motivation and structure. Neoclassical economists (Rodriguez 1976; Hamilton and Svenson
1982) follow two different strands of thought. On the one hand, there are those who suggest that
establishing SEZs is not only distortive for competition but also welfare decreasing. More
specifically, they argue that special zones distort allocative efficiency, forward unfair practices
of competition between domestic and zone firms, deprive crucial state resources and impose
high infrastructure costs especially in developing countries (Warr 1989). Further, the zones act
as a disincentive for factor-based competitive exports failing to bring fundamental structural
reforms at regional/national level (Schrank 2001). Hamada (1974) used a two sector model and
also affirmed the distortive consequences of special economic zones on economy.
The conclusion of the aforementioned analysis is that in an internationalized trade environ-
ment the rationale in favour of special zones loses ground as the national economic conditions
become favourable to entrepreneurship and the country fits its Hecksher-Ohlin comparative
advantage. Seshadri (2011) studying India has also concluded that there is no obvious correla-
tion between export growth and export zones arguing that trade liberalization and reforms seem
to better explain export performance. Similarly, Pouder and St. John (1996) illustrate that the
logic of special economic zones favours clusters characterized by a homogeneous macro culture,
leading to less innovation. As a result, economic agents become exposed to a progressively
narrower range of information resources and productive routines result in economic stagnation
instead of economic productivity. Equally important, encouraging industrial relocation through
incentive mechanisms constrains entrepreneurship and accentuates developmental difference
between and within regions in developing states.
On the other hand, there are authors who perceive special zones as a second best solution
(Engman et al. 2007) in highly distortive political-regulatory environments with no short term
alternative for regional/national competitiveness. Thus, if freer trade is not politically viable in
the medium term, special economic zones could be useful as vehicles to introduce economic/
liberalization reforms, facilitating the transition from state dependent and import substituting
production structures to free trade regimes. However, as states apply crucial macroeconomic
reforms and diffuse liberal strategies and principles, special economic zones role will be
considerably reduced (Madani 1999). This clearly means that under certain terms, special zones
could be used as the first stage of economic restructuring and productive modernization in a
developing country (Wong and Chu 1984).

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90 K.J. Hazakis

The paper considers the neoclassical approach as not proper for exploring issues of com-
petitiveness in developing states (Hazakis 2011). Instead, it adopts institutionalist analysis
arguing that regional economic development is a set of interrelated firm strategies, institutional
processes, regional routines and regional tangible/intangible competences, leading to systemic
economic restructuring and effective allocation of local resources. Accordingly, the challenge of
a special economic zone is to bring simultaneous modification of institutional/structural
elements of economic organization and patterns of economic action, locally and regionally. For
this to happen, a conditio sine qua non is institutional thickness (Amin and Thrift 1994). The
latter clearly presupposes shared norms and values of all institutions within a local/regional
economy. Under specific conditions, special zones could facilitate agglomerations and may
enable the weak regional industrial structures to overcome minimum size thresholds, forwarding
strong scale economies.
Equally important, institutional economics emphasize the social context of economic action
and the evolutionary nature of economic development providing crucial insights for political
economists interested in how institutional and social terms influence SEZs purpose and perfor-
mance. As North (1994) put it in more general terms, firms interact on markets which are social
constructions embedded in territorially specific institutions which permit transactions and define
property rights. Thus, departing from neoclassical methodological individualism in which
economic behaviour is limited to the responses of utility-maximizing SEZ economic agents,
institutional analysis focuses on the interplay of structures and economic agents within SEZ
specific settings.
Accordingly, success and failure of SEZs in terms of routines, practices and competences is
examined at micro level of actors, at the meso level of networks and at the macro level of SEZs
economic – institutional – social environment. SEZs’ performance heavily depends both on
intra-organizational resources (embedded in firms’ routines/behaviour), extra-organizational
resources (such as tacit knowledge, relational and social capital and institutional competences)
as well as on their dynamic interaction. Most of these resources are of non-tradable nature and
often act as de facto selection mechanisms against firms which do not have either the intention
or the absorptive capacity to participate in a successful SEZ. It is thus argued that differential
outcomes across SEZs are due in part to varying degrees of mismatch between specific
institutional/economic/social endowments, localized economic potential and learning/
adaptation ability of incoming foreign firms.
Indeed, efficient institutional-social conditions influence routines and economic behaviour
of firms and have a clear impact on entrepreneurship and innovation. More specifically, suc-
cessful SEZs not only affect the intensity and nature of economic actors’ interactions and
economic actors’ behavioural patterns but provide solutions to five problems at regional level,
namely, knowledge failures, network failures, co-ordination failures, innovation failures and last
but not least high transaction cost levels. Thus, effective SEZs could be an answer in cases of
developing countries where positive externalities tend to be under-supplied due to predominance
of oligopolistic/monopolistic rationale (e.g., fundamental skills or high value added research
and development). Taking into account that moral hazard produces negative spillovers not only
in financial terms (crowding out effect) but also in terms of social capital and networking (e.g.,
low levels of reciprocity and trust in regional economic co-operation and clusters), effective
SEZs could bypass clientistic and corporatist economic organization at regional level.
Successful SEZs do address market imperfections and collective action defects and provide
necessary terms for fruitful interaction between local/regional structures, networks and incom-
ing firms. The superiority of institutional analysis of SEZs is derived by its holistic nature
(focusing on the causal links between SEZ organizational/institutional authority and economic
agents /networks), its systemic nature (focusing on interactions of structures and economic
agents) and its evolutionary nature, (socio-economic conditions and path dependence influence

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The rationale of special economic zones 91

the scope and evolution of SEZs). An institutional approach on SEZs gives rise to a specific
context of regional economic development and to a particular group of development values in
terms of which SEZ performance is evaluated. It is not coincidence that neoclassical methodo-
logical individualism has been criticized by prominent authors in economics because as Trygve
Haavelmo (Nobel Laureate) noted (1997, p. 15) “existing economic theories are not good
enough . . . we start by studying the behaviour of the individual under various conditions of
choice . . . we then try to construct a model for the economic society in its totality by a so called
process of aggregation. I now think this is actually beginning at the wrong end . . . Starting with
some existing society, we could conceive of it as a structure of rules and regulations within
which the members of society have to operate. Their responses to these rules as individuals
obeying them produce economic results that would characterize the society”.
The paper argues that there are three fundamental pillars in an institutionalist analysis of
SEZs. The first pillar is the normative one, emphasizing the system of prescriptions, evaluations
and responsibilities in an SEZ that influence behavioural traits of economic agents. The norms
specify how economic actions influence goals, means and behaviour of economic agents. They
also impose constraints on economic behaviour and enable specific patterns of economic
activity. Rules are also vital because as Young (1989, p.16), puts it, they are considered “well
defined guides to action or standards setting for the actions that members are expected to
perform (or to refrain from performing) under appropriate circumstances”. SEZ rules are
prescriptive, requiring economic actors to behave in a specific manner, they are procedural,
providing ways that allow economic actors to arrive at collective solutions regarding hurdles of
SEZ networks and they are constitutive, determining what type of authorities, competencies and
capabilities are granted within SEZs. Therefore, SEZ normative analysis focuses on enduring
regularities of economic behaviour, observed in SEZ structures, rules and norms.
The second pillar is the cognitive one, focusing on the influence of SEZ principles and
mental models in shaping of economic action meaning within an SEZ. Emphasis is on the
creation of shared knowledge and belief systems and not only on regulations and guidelines of
economic activity (first pillar). As Hodgson (2009, p. 15) eloquently mentions, “any form of
rationality in a minimally complex environment relies on cognitive framing, selection and
interpretation to make sense of its information inputs”. Based on the second methodological
pillar, economic actors understand a common frame of reference, perceive “SEZ identity”,
translate local/regional codes of economic co-ordination and adopt implicit/explicit norms of
inclusion/exclusion in SEZ networks. Failure of an economic actor to behave in ways that
accord with SEZ cognitive norms, signals his exclusion from SEZ networks functionally and
morally. Moreover, efficient cognitive networks of SEZs promote learning/adaptation by partly
socializing the risk involved in network collaboration and by partly rationalizing the uncertainty
associated with one-off economic transactions. Equally important, common frameworks of
understanding promote repeated interactions and enforce co-operation schemes for knowledge
sharing among SEZ firms. On the other hand, absence of a clear cognitive framework reduces
economic agents’ complementarities, strengthens inter-firm contradictions and raises transac-
tion cost.
How regulative and cognitive analytical levels are linked in an SEZ study? The communi-
cation of economic information and knowledge requires shared conventions and rules and the
latter are being enforced at all times by the acceptable mental models of economic actors. North
(1994, p.363) eloquently notes that “belief structures get transformed into societal and economic
structures by institutions – both formal rules and informal rules of behaviour. The relationship
between mental models and institutions is an intimate one”.
Finally, the third pillar is the organizational one and includes organizational infrastructure
and decision-making procedures in a SEZ. This twofold pillar embodies specific gover-
nance structures determining which economic agents are included in different types of

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92 K.J. Hazakis

decision-making within SEZs, how economic information is processed and what type of eco-
nomic behaviour is adopted at different levels of action. An efficient organizational framework
not only faces the classical problems of bounded rationality, asymmetric information and
conflicts of interest but could also isolate vested interests and corporatist pressures.
How cognitive and regulative are connected to the organizational pillar? The latter de jure
legitimates patterns of economic behaviour and guarantees functionality of SEZs rules/
regulations, embedding the ideational base of SEZ targeting. In this way the institutional
complementarities are maximized as the effectiveness of an SEZ institution increases the
positive spillovers from other SEZ institutions and SEZ networks. Indeed, strong cognitive and
regulative frameworks are not sufficient for promoting interactive learning/adaptation processes
in SEZ networks. There is a need for efficient organizational mechanisms that co-ordinate the
action between agents and provide essential inputs/complementarities for innovation. Thus, the
competitiveness of a SEZ depends not only on the presence of a critical mass of efficient
economic agents but also on the capacity to incorporate diverse agents in properly organized
local economic structures. Nel et al. (2013) argue that the broader policy framework is funda-
mental in SEZ success while the empirical analysis of Wang (2013) on Chinese SEZs also
underlines that SEZs policy package including private property rights protection and land use
policy, could increase per capita foreign direct investment in SEZs. Organizational level also
permits a strong and legitimized adoption of shared interpretations of economic action. As Scott
(1987, p. 495) mentions, “These interpretations or typifications are attempts to classify the
behaviour into categories that will enable the actors to respond to it in a similar fashion. The
process by which actions become repeated over time and are assigned similar meanings by self
and others is defined as institutionalization”.

4 The fundamental institutional principles for SEZ analysis

Although institutional economics provide a solid methodological framework for economic

analysis since the 1970s (Williamson 1985), the approach remain ambiguous in issue-areas like
SEZs rationale and the fundamental role of SEZ institutions in local economic development. The
paper argues that it is possible to trace seven key principles in institutional analysis of SEZs
allowing clear perception of fundamental aspects of SEZ institutional context.
First, SEZs are context-dependent in the meaning that performance outcomes are not totally
inherent in the model of zones but rather in their implementation. Likewise, the configurations
of SEZs organizational – regulative – cognitive arrangements that influence the behaviour of
economic agents cannot easily be transferred for the reason they are embedded in a complex
socio-economic system of production/exchange. The latter influences network and individual
economic performance and explains why SEZs possess different innovative systems and why
they vary in the clusters of firms in which they have comparative advantage. Institutionalism
uses very often the term ‘path dependency’ to refer to the ways in which the evolution of firms
and territories are structured by certain trajectories of development as a result of past decisions
(Arthur 1994). North (1997, p.15) also highlights that “path dependence can and will produce
a wide variety of patterns of development depending on the cultural heritage and specific
historical experience of each country”. Thus, the term is considered as “a way to narrow
conceptually the choice set and link decision-making through time”. It is not a story of
inevitability in which “the past neatly predicts the future” (North 1990, p. 98). As Granovetter
also notes, (1985, p. 487) “actors do not behave or decide as atoms outside a social context.
Their attempts at purposive action are instead embedded in concrete ongoing systems of social
relations”. In another argument, embeddedness of both firms and SEZs in a region point out the
importance of local conditions and conventions as sources of potential competitive advantage.

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The rationale of special economic zones 93

Consequently, what worked well in SEZs in South Korea may fail in the Shannon SEZ in Ireland
if implementation does not take into serious consideration the peculiarities of a region. This also
means (Farole 2011) that a strong legal framework cannot always face disputes between the state
and zone developers or solve infrastructure deficiencies (e.g., Ghana and Senegal).
Equally important, complex interplays of policy application and context that include factors
such as timing of decision-making procedures, the nature/quality of local institutions and
informal routines/practices of economic agents influence significantly SEZ performance. As
Tantri (2012, p. 333) demonstrated in his analysis on seven conventional SEZs in India, policy
changes effected in 2000–2001 exerted important influence on output/export efficiency of SEZs.
Moreover, SEZ institutional settings are also context specific and quite similar to the way firm
knowledge base accumulates. Both firm and SEZ sources are being reproduced in the course of
time and as Maskell (1998, p. 112) emphasizes, “Transferability over time but not over space can
enable localized industries to sustain their competitiveness”. Edquist (1997, p. 20) also stresses
that “when innovating, firms interact more or less closely with other organizations, they do so
in the context of existing laws, rules, regulations and cultural habits”. Therefore, it is not the
individual firm or only the individual SEZ authority which matters but rather their interaction
within specific socio-economic conditions.
Storper (1997) further indicates that firms and organizations become attached to specific
regions through the development of untraded interdependencies that are rooted in regionally
specific routines. Obviously, these interdependencies have a strongly place-bound and culturally
originated type and cannot completely be transferred from one region to another (Putnam et al.
1993). So, path dependence is related not to lock-in static arrangements but rather to the
accumulation of knowledge and experience, to the enforcement of social capital and to effective
application of learning/adaptation mechanisms. This is why SEZs as socio-economic and
organizational entities differ in their competences and also differ in their adaptative capacity to
the transformative structures of global production/commerce. That is also why effective and
successful SEZs do not reproduce vested interests in lagging regions but build on regional
potential in order to make network capacities compatible with global needs and necessary for
global competitive goods production (e.g., Masan free zone in South Korea promoted export
oriented competitive clusters in high value added manufacturing activities).
Consequently, there exists a wide diversity of SEZ trajectories that differ with respect to
which organizational traits are involved in the innovation process (e.g., research institutes,
public agencies), how economic knowledge is diffused through networks in SEZs, which SEZ
institutions affect economic performance and how SEZ institutions are modified and trans-
formed in organizational terms (e.g., public-private partnerships) or in policy terms. For
example, the Dominican Republic and Honduras permitted SEZ management to be carried by
private companies (Altbeker et al. 2012) while in China, Tanzania and Vietnam, SEZs are based
on public-private partnerships (Farole and Kweka 2011) and the Panama Colon Free Zone is
administered by a state owned firm (Sigler 2013). Of course, practice clearly underlines that
public or private management does not lead per se to efficiency. As Farole states (2011, p. 192)
“Ghana’s zone program paid a heavy price for picking up an inappropriate private partner to run
its flagship zone project in Tema”. This context-specific and path-dependent SEZ is highly
related to the SEZ role on learning process and accumulation of knowledge.
Thus, the second major principle of SEZ institutional analysis is that successful zones
enhance regional ability to organize endogenous learning processes creating favourable struc-
tures for policy learning. As North (1990, p.78) points, “The institutional framework will shape
the direction of the acquisition of knowledge and skills and that direction will be the decisive
factor for the long run development”. For example, the Penang Skills Development Center in
Malaysia was a co-initiative of the Malaysian state and foreign private firms to provide up-to-
date training and educational programmes in support of operational requirements, evolving

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94 K.J. Hazakis

skills of local staff (up to 2011 the centre has trained more than 150,000 workers through almost
7,000 courses helping significantly, national policy for human capital upgrading). Honduras also
implemented a successful vocational training Institute in 2005 providing workers with the skills
demanded by firms in courses lasting 2–18 weeks (Farole 2011). In developed states, training is
also given priority as an incentive to attract foreign investors in special zones. For example, the
Welsh government is offering financial incentives for well known firms such as Deloitte to
expand their operations in Cardiff providing financial support for the training of new employees
(FDI supplement 2013a) while Derby in East Midlands of the UK favours partnerships between
big local employers and Universities (University of Derby and Derby College) to establish
efficient apprenticeship academies for local staff (FDI supplement 2013b). It is also no coinci-
dence that important clusters in China, began to grow out of SEZs such as the information and
communication technology clusters in Zhongguancun (Beijing) and Shenzen, the electronics
and biotech clusters in Pudong (Shanghai), the software cluster in Dalian and the optoelectronics
cluster in Wuhan (Zeng 2010). Thus, an efficient SEZ should always address regional economic
failures through flexible and transparent adaptation mechanisms and through local learning
practices. Porter (1998, p. 78) also mentions that “what is decisive is learning and innovation in
a way that is specific for a region and which leads to the improvement of the particular regional
comparative advantages, that distant rivals cannot match”. For example, in Suzhou Technologi-
cal Park (China), the government offers information services, laboratories, product testing
centres and technology trading rooms, while in Tianjin economic-technological development
area the government has built technology innovation platforms such as innovation parks
research and development centre and industrialization bases (Zeng 2010).
Obviously, SEZs could promote network learning by communicative mechanisms that
permit joint strategies and long-term collaborations of firms within the zones. Economic agents
in SEZ networks are motivated to learn by the promise of new opportunities and achieving better
access to new information, finding solutions to collective economic problems regarding network
productivity/export performance. Of course, to what degree SEZs networks are proved efficient
in the long term policy learning depends on the structures of networks, on the patterns of daily
interaction and on the ability of SEZ firms to manage co-operation/conflict in regular transac-
tions. Similarly, SEZs ameliorate receptivity and absorptive capabilities in firms through
network interaction. This also suggests that SEZ is a key mechanism to co-ordinate the exchange
of complementary pieces of knowledge owned by different actors. But which are the charac-
teristics of the aforementioned knowledge? Antonelli (2005, p. 67) stresses four traits of
knowledge that do matter and are the following:

1. knowledge is dispersed and fragmented, scattered among a myriad of economic actors;

2. no actor can possess and control all knowledge and the complementarity among modules of
knowledge possessed by each actor is relevant;
3. proximity among economic actors is relevant for the complementarity among external and
internal knowledge as well as among the learning efforts of each economic actor and the
modules of knowledge possessed by each economic actor; and
4. agents can learn and make intentional efforts to provide new knowledge based upon pro-
cedural rationality, to modify locally (because of switching costs) their position within the
knowledge networks.

Taking into account that transfer of tacit knowledge depends on reciprocal and stable
arrangements, SEZs could be the framework to bridge communication gaps between ‘suppliers’
and ‘buyers’ in a local/regional network. Breschi and Malebra (2001, p. 819) further underline
that “a key feature of successful high technology clusters is related to the high level
embeddedness of local firms in a very thick network of knowledge sharing which is supported

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The rationale of special economic zones 95

by close interactions and by institutions building trust and encouraging informal relations
among actors”. In TEDA (Tianjin, China) for example, 11 incubators favoured the establishment
of six clusters in electronics, optics, biomedicine, energy, machinery and environmental pro-
tection and gave rise to 45 research and development centres of well known multinational
companies (Zeng 2010).
However, learning/adaptation and receptivity could not be achieved without transparent and
long term ‘rules of the game’ in SEZs. Accordingly, the third characteristic of SEZ institution-
alist analysis is the implementation of rules of the economic game (North 1991) within all issue
areas of an SEZ and of course the specification of incentive structures. As North (1990, p.47)
argues “economic rules define a property rights that is the bundle of rights over use and the
income to be derived from property and the ability to alienate an asset or a resource”. All SEZ
incentives can be seen as mechanisms of a regulatory regime creating opportunities for eco-
nomic action. Hence, pre-eminence is given to transparent regulative processes such as rule
setting, monitoring and sanctioning illegal activities rather than to interventionist mechanisms of
picking up economic champions. For example, in Shenzen (China), the government established
a unified online platform for government procurement to increase transparency and launched an
electronic monitoring system for administrative licensing (Zeng 2010). Nevertheless, one
should always have in mind that there is ‘a regulatory Luffer curve’ where beyond a certain
threshold, strong regulatory activity from SEZ authority exercises a negative effect on SEZs
overall performance. Nigeria (Farole 2011) suffered from a significant gap between de jure and
de facto implementation of SEZ related laws while in Tanzania the existence of parallel
programmes for SEZs confused potential investors and raised uncertainty and transaction costs.
Obviously, rules have a triple role in an SEZ, namely, they reduce uncertainty/transaction cost,
they define incentive structures and they act as anchors of reference for incoming firms.
Particular interest is also placed upon developing and strengthening unwritten codes of
conducts in order to establish efficient rules of economic game, permitting economic agents to
identify cost/rewards/penalties attached to different types of economic behaviour. Unavoidably
than, conditional subsidies/incentives are considered superior to unconditional incentives as the
former increase the value of firm performance.
But how rules of the game could be assessed in a SEZ? Based on Legro’s (1997) general
analysis of norms/rules, three criteria are considered crucial for SEZs, namely, simplicity,
durability and concordance. Simplicity refers to how economic agents understand norms and
rules, and how well they can be implemented within SEZ territory. Durability faces the issue of
how long SEZ norms/rules have been in effect thus the degree of their efficiency as well as the
degree of their legitimacy. Last but not least, concordance refers to how (widely) applied a SEZ
rule/norm is. It examines how a SEZ rule incorporates economic agents’ specific norms/routines
and thus acts as a meta-rule. Perhaps a fourth criterion could be the intensity with which norms
are held by economic agents. Some norms may involve low level of obligation whereas others
may be well internalized. Usually, a key problem in SEZ operation is the lack of all aforemen-
tioned criteria in inter-agency co-ordination and the result is too often overlapping responsibil-
ities and actions. As Farole (2011) illustrated, the lack of formal institutional links among key
agencies, in Tanzania, Nigeria, Kenya and Bangladesh, created operational disconnect. On the
other hand, the Dominican Republic and Jordan (Aqaba special economic zone) delivered clear
responsibilities to all involved agencies, facilitating foreign investment and cross agency
co-ordination. In some countries (e.g., Lesotho) clear delineation of authority is even based on
memorandum of understanding in order to avoid interagency conflict.
The role of networks in an SEZ (fourth institutionalist trait) is crucial because it enforces the
transparency of the rules of the economic game, emphasizing specific prescriptions and obli-
gations which are considered essential for long term inter-firm collaboration. Networks traits
include mutuality, trust and co-operation binding together economic agents (Dore 1983),

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96 K.J. Hazakis

decision-making procedures, knowledge flows, innovation capabilities and relational assets. The
latter (Storper 1997) are non-tradable, nor easily substitutable, including tacit knowledge,
embedded routines/norms and communicative structures. Through long-term SEZ networks
learning and adaptation, market uncertainty, informational asymmetry and knowledge
boundness are better faced. Networks also minimize transaction costs while placed in a situation
where any infringement of trust is penalized, rendering malfeasance a non-option (Casson
1991).
Agglomeration of economic activity in SEZ also favours positively firm growth since export
oriented firms allow both suppliers and buyers to compensate for variability and uncertainty,
providing ready access to needed resources at short notice. Free zones in Dubai, Sharjah and
Ajman in United Arab Emirates are seen as basically one city, integrating complementary
activities within a unified economic space (FDI supplement 2013c) while in China the location
advantage is obvious for the SEZs in the Pearl River Delta region (close to Hong Kong) and the
Min Delta region (close to Taiwan). Thus, with the exception of small states (e.g., Mauritius
where the small size of the state gives easy access to infrastructure as no firm in an SEZ is more
than 60 km from airport and port) location does play a significant role (Farole 2011). The
Philippines also took lessons from the failure of the Bataan free zone and established two zones
(Mactan and Baquio city) in late 1970s near urban industrial centres with access to a skilled
labour force and key infrastructure. On the other hand, zones in Northern Bangladesh are located
more than 600 km from an international port, making difficult the establishment of export
oriented foreign firms. Further, localized concentration of high level suppliers also permits
higher productivity performance, strong innovation performance and intense knowledge
spillovers (Audretsch et al. 1996). In China for example, the promotion of clusters is based on
an explicit industrial model favouring spatial agglomeration of industrial firms in specialized
towns. The latter, established specific information networks, innovation centers and research and
development centres with leading firms in order to ease agglomeration innovation capacity and
spatial technological upgrading (for an analysis of Guangdong experience see Barbierri et al.
2012). The more the knowledge spillovers in an SEZ, the higher the number of connections with
global networks and the more information is available through productive/commercial linkages
to SEZ economic actors. Apparently, reinforcing firm receptivity favours the dissemination of
knowledge to networks through alignment of research activities of SEZ firms and thus forwards
complementarities. Although SEZ authorities do not enforce knowledge patterns, they provide
key inputs for dynamic co-ordination among economic agents involved in knowledge
/innovation creation. Obviously, SEZ priority is to strengthen SEZ networks instead of individ-
ual economic agents and preference is given to economic interactions and network implicit/
explicit governance norms/structures rather than on micro-firm organizational traits. Further,
transaction cost is reduced through mutual trust and understanding, building strong network
rationalities and cognitive frameworks rather than providing generous incentive schemes to
isolated firms.
Equally important, the role of an anchor investor is crucial for the success of an SEZ as
examples throughout the world suggest. In the Philippines, the Texas Instruments establishment
in Baquio city SEZ contributed to the attraction of key investors while in the UK, East London
IDZ is based on subcontractors-suppliers of the Mercedes plant in the area (Altbeker et al.
2012). Similarly, the Intel establishment in Costa Rica’s SEZ was used as a magnet for the
attraction of other foreign firms internationalizing further SEZ activities. The same role is
attributed to Rolls Royce in the Derby area because it acted as a magnet for Japanese car
manufacturer Toyota, Canadian rail firm Bombardier and for the construction company JCB
(FDI Supplement 2013b).
However, even agglomeration effects are not sufficient for innovative performance and what
is too often missing is social capital (fifth institutionalist characteristic). When the cognitive

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The rationale of special economic zones 97

framework of an SEZ is weak or incoherent and when social capital is undermined, costs of
co-ordinating even complementary firm resources is high. Evidently, interactive learning cannot
be realized as exchanges take an ad hoc and one-off subcontracting nature without profound
long term synergies. Thus, institutionalist analysis argues that social capital contributes to stable
inter-firm communicative structures and thus inter-firm relations are less in danger by zero sum
competitive behaviour since all potential conflicts are accommodated within the cognitive/
operational limits clearly prescribed in SEZs. Which are the necessary traits of SEZs social
capital?
At the heart of social capital is trust which forwards exchange of knowledge and reduces
levels of heterogeneity both in preferences and in individual SEZ economic agents’ knowledge
endowments. Reputation and reliability of SEZ firms is also enhanced through trust-shared
interaction because expectations held by one economic agent that another economic agent will
behave in a well known (and network appropriate) manner with regard to an issue, are specific.
Firms even ignore sometimes promising co-operative alternatives outside SEZs since they
perceive them as evolving high adjustment costs, risks, uncertainty and low trust. Putting it
differently, the clear boundaries of networks based on trust and reciprocity of insiders acts as
constraints on the ability of non-network companies to steal co-operation.
Putnam et al. (1993) emphasized in specific the positive effects of reciprocity existed in
social capital listing four reasons for enhancing co-operation:

1. it increases the costs of defection;

2. it fosters robust norms of reciprocity;
3. it facilitates communication improving information flows; and
4. it embodies past successes at collaboration and provides a strong blueprint for future
co-operation.

As Cooke (2002, p. 99) points, “the evolution of innovative capacity . . . relies fundamen-
tally on the activation of social capital and the propagation of trustful relations among diverse
actors”.
Overall, SEZs with strong social capital not only provide efficient access to local resources
and knowledge (connectivity) but also a context in which firm and regional capabilities (too
often tacit in nature) are recombined through economic agents’ interaction (receptivity). This
also favours the above mentioned first dimension of institutional approach since it creates
conditions for cumulative and context specific learning as well as it improves terms of innova-
tion capacity. As Nasra and Dacin (2010) illustrated in Dubai’s case, these networks were
influential during key events such as gaining local and financial support for the creek dredging
project. They further underline that Dubai’s economic zones managed to mobilize fundamental
intangible assets and resources through networks built with the trading and merchant commu-
nity. Moreover, they noted that social ties and network links facilitated the formation of political
capital that increased legitimacy of state institutional activities and facilitated success. In China
too (e.g., in Wenzhou), SEZs’ efficient operation depends on information networks and social
capital. Zheng (2011) also notes that in China’s SEZs, firms tend to prefer oral agreements based
on community ties and reputation and even operate on funds borrowed by firms within the SEZ
cluster network due to deficiencies of the formal judicial system. Finally, De Carolis et al.
(2009) underlined the impact of network links and social capital in new venture activities.
Sixth, SEZs focus on an improved investment climate which lowers transaction cost and
uncertainty. It should be specified that investment climate is not the general impression of laws
and policies within SEZs but is a specific firm perception on the risks, opportunities and threats
within an SEZ as well as a firm perception of the outcomes of de facto application of regulations
in an SEZ (Hazakis 2001). Apparently, an improved and transparent investment climate can

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98 K.J. Hazakis

delete the negative traits of path-dependency acting against lock-in mechanisms of local vested
interests. It further means enforcement of key factors for FDI inflows such as infrastructure,
logistics and business regulations. In the case of Kunshan (China), for example, before it was
even approved as a special zone in 1992, all infrastructures had been built by the local
government on a self financing basis (Zeng 2010).
Finally, the institutionalist approach is in favour of an on-going impact assessment of a SEZ
taking into consideration all potential outputs of SEZs activity on local/regional economy and
society (seventh feature). More specifically, it is argued that social and economic impact
assessment (SEIA) of an SEZ is a dynamic/analytical framework of:

1. identifying potential impacts from SEZ that is to be applied in a geographical area;

2. assessing costs-benefits-risks caused by the SEZ across local/regional society;
3. tracing social and economic norms, values and principles that may rise as a result of SEZ
establishment;
4. applying mitigation policies to address intended and unintended impacts (as they develop) in
order to limit transaction cost and uncertainty; and
5. examining the compatibility of SEZ targets with the development priorities of local societies.

Thus, all possible impacts are categorized according to their nature, their type, their mag-
nitude, their significance, their scale, their duration, their intensity and their reversibility
(Hazakis and Mourmouris 2012).
The aforementioned analysis enriches understanding of SEZ rationale from an institution-
alist methodological approach underlining the dynamic interaction between cognitive, regula-
tive and organizational traits of SEZs. It further suggests that a solid methodological institutional
framework is highly useful in maximizing SEZ performance taking into consideration the
targets of economic agents and the complexity of contemporary global production structures.

5 Conclusions

The process of globalized economic/production restructuring forwards new types of regional

differentiation. Based on a new definition of SEZs and on the institutional methodological
premises, the paper argues that efficient SEZs are of considerable importance in influencing how
regions respond to fierce competition and poor local inter-firm synergies.
To begin with, SEZ networks do play a crucial role embedding different economic agents in
terms of knowledge, economic size, sectoral specialization, competences and activities. As a
consequence, inclusion/exclusion of firms is taking place relatively to the cognitive/normative/
regulative frameworks of SEZs. The more transparent such frameworks are the better economic
agents perform. Accordingly, strong identity SEZ networks do not impose hierarchies based on
deprivation of resources but rather promote adaptation/learning processes for all SEZ firms.
Equally important, co-operative inter-firm links based on robust social capital and regional
competences advance regional development targets instead of regional inter-firm rivalries and
vertically constructed low value added chains (Hazakis and Ioannidis 2011). Efficient institu-
tions in SEZs do not limit economic agents’ preferences but rather enable enhancement of
economic agents’ choices, shaping in constitutive terms a stable and red-tape free entrepreneur-
ial environment.
It is further suggested that key hurdles for efficient SEZs are not only poor institutional
design, unconditional concessions on duties and taxes to firms, inefficient infrastructure and
inadequate skills, but also inconsistent policy tools for SEZ targeting. This means that SEZ
performance is directly linked to the effectiveness with which SEZ institutions perform their
duties and only partly to the official organizational form that SEZ institutions adopt.

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The rationale of special economic zones 99

Finally, path dependence introduces a variety of context-specific policy actions and

reinforces a policy against ‘one size fits all’ SEZ model. What is considered an efficient SEZ
organizational/institutional framework in one country does not necessarily means an efficient
framework in another. Thus, better match between SEZ institutional framework and regional
competences as well as compatibility between SEZ cognitive/normative/regulative framework
and global business networks’ targets are key issues for SEZ efficiency. The density of
tangible/intangible firm competences, the strength of social capital, the local institutional
thickness and the strength of regional competences in a SEZ, favour sustainable regional
economic development.
Overall, SEZs might prove to be catalysts of structural transformation if they are embedded
in market-oriented policies that emphasize export orientation, real productivity in medium/high
value added sectors and functional integration in global networks of production/trade. Thus, the
key issue is how to shift from traditional hierarchical perception of SEZ economic governance,
(e.g., strong government intervention), towards terms of mutuality and interdependence between
SEZ economic agents and SEZ institutions. The challenge is how to develop co-operative
options in which interactive economic co-ordination could draw in both local institutions and an
enlarged group of economic agents.

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 doi:10.1111/rsp3.12030

Resumen. Los estudios sobre la economía de las zonas económicas especiales (ZEE) han
florecido en los últimas tres décadas. El artículo enriquece la comprensión de la justificación de
las ZEE a partir de un planteamiento metodológico institucionalista. El argumento principal es
que la literatura debería examinar los procesos mediante los cuales interactúan los rasgos
cognitivos, reguladores y organizativos de las zonas económicas especiales. Se argumenta que
la disparidad metodológica entre los agentes económicos, las estructuras institucionales y las
organizaciones de las ZEE podría reducirse si se arrojara más luz sobre su interacción, en lugar
de su separación analítica. Con igual importancia, se afirma que la interacción de las estructuras
de las ZEE y los agentes económicos de las ZEE determina el éxito o el fracaso de las zonas.

© 2014 The Author(s). Regional Science Policy and Practice © 2014 RSAI

Regional Science Policy & Practice, Volume 6 Number 1 March 2014.