PRM Policy Note

Pakistan Resident Mission

November 2007

Series No. 2

Special Economic Zones and Competitiveness

A Case Study of Shenzhen, the People's Republic of China

Wanda Guo and Yueqiu Feng

www.adb.org/prm/publications.asp

Pakistan Resident Mission Asian Development Bank 1st Floor, OPF Building Sharah-i-Jamhuriyat, G 5/2 Islamabad. Pakistan 2007

PRM Policy Note Series Review Committee Chair: Peter L. Fedon, Country Director, Pakistan Resident Mission Asian Development Bank Members: Emma Xiaoqin Fan, Senior Public Resource Management Specialist Safdar Parvez, Economist Coordinator: Khurram Butt

The PRM Policy Note Series is based on papers and notes prepared by PRM staff and resource persons. The series is designed to provide concise non-technical accounts of issues of policy importance to Pakistan. Feedback is welcome via e-mail (adbprm@adb.org). PRM welcomes submission of brief papers from both ADB staff and external contributors for the PRM Policy Note Series. The papers can be submitted to Ms. Emma Xiaoqin Fan (xfan@adb.org) and Mr. Khurram Butt (kbutt@adb.org). The views expressed in the series are those of the authors and do not necessarily reflect the views or policies of the ADB.

PRM Policy Note

Pakistans Resident Mission
November 2007

Series No. 2

Special Economic Zones and Competitiveness

A Case Study of Shenzhen, the People's Republic of China

Wanda Guo and Yueqiu Feng

www.adb.org/prm/publications.asp
Dr. Wanda Guo is vice-president of the China Development Institute (CDI), and Ms Yueqiu Feng is director of the CDI's International Cooperation Department. This paper was presented at the Pakistan Development Forum in April 2007. The authors thank Peter L. Fedon, Emma Xiaoqin Fan, and Safdar Parvez for comments and suggestions; Maheen Pracha for copy editing; and Khurram Butt for coordinating the publication of this issue.

Contents
Abbreviations 1 2 3 4 5 6 Introduction SEZs compared to Industrial/High-Tech Parks The Development of the Shenzhen SEZ Factors Underpinning Shenzhen's Success Key Policies Contributing to Shenzhen's Industrial Competitiveness Conclusion 1 3 5 7 9 11

Abbreviations
ADB FDI GDP PRC PRM SEZ Asian Development Bank foreign direct investment gross domestic product People's Republic of China Pakistan Resident Mission special economic zone

(i) In this paper, "$" refers to US dollars.

1. Introduction
Special economic zones (SEZs) have played an important role in advancing economic reform in the People's Republic of China (PRC) and, particularly, in opening up its economy to the rest of the world. The Shenzhen SEZ was the first SEZ to be set up in the PRC. Over the past few decades, Shenzhen has developed from being a small fishing village in Guangdong Province into a major industrial and financial center, benefiting substantially from the liberal economic policies granted by the Central Government to SEZs. Shenzhen's rapid development has showcased the advantages of open door policies and market-oriented reforms, served as a laboratory for piloting policies, and propelled economic development in the rest of the country. This policy note briefly documents the experience of Shenzhen and analyzes the factors that have contributed to its emergence as a successful SEZ. There are useful lessons to be drawn from Shenzhen's experience by countries such as Pakistan in designing their economic reform policies. The major findings of this policy brief are summarized below. The experience of Shenzhen has demonstrated the important differences between a special economic zone and an industrial/high-tech park. A SEZ is a comprehensive laboratory in which fully fledged economic reforms can be

piloted, while industrial parks are a supporting component of SEZs, but with an industrial focus. SEZs in the PRC are authorized by the Central Government and cover large administrative areas such as an entire province or a city. In contrast, industrial parks are authorized by provincial and municipal governments, and generally encompass only part of a city. There are over 1,500 industrial parks in the PRC, but only 7 SEZs. In this sense, few countries in the world have SEZs, while most have industrial parks. Too often policies of setting up isolated industrial parks lead to the development of enclaves which are unable to propel sustained economic growth. Given the importance of SEZs in testing and showcasing the success of economic reforms, the PRC's experience on SEZs sheds light on the concept and potential of SEZs for other developing countries. The success of Shenzhen further demonstrates the importance of an enabling policy environment. In particular, Shenzhen's experience indicates the benefits of open and market oriented economic polices. Indeed, Shenzhen has enjoyed by far the most open and market-oriented economic policies in the PRC. This has attracted not only young and skilled migrants from across the country, but also large inflows of foreign direct investment (FDI), transforming a small village into a financial and industrial hub. This openness to both financial and human capital has promoted fast economic growth, which has, in turn, been beneficial for generating employment, improving people's livelihoods, and reducing poverty. Shenzhen serves as a good example of how industrialization and urbanization can act as catalysts for economic development. By implementing comprehensive economic reforms, SEZs ultimately unify the industrialization and urbanization processes.

2. SEZs compared to Industrial/High-Tech Parks

SEZs were established in the PRC as early as 1980. The Central Government has so far only authorized seven SEZs. These are occasionally referred to as the 4+2+1, where (i) 4 refers to the first group of SEZs that were authorized in 1980-Shenzhen, Zhuhai, Xiamen, and Shantou; (ii) 2 refers to the new Pudong district in Shanghai and Hainan province, both authorized as SEZs in 1990; and (iii) 1 refers to the Newly Developed Area of Tianjin Binhai, which was authorized in 2006. The key differences between SEZs and industrial/high-tech parks are outlined below. (i) Essentially, a SEZ is an administrative division: it can span an entire province, such as Hainan; entire cities, such as Shenzhen, Zhuhai, Xiamen, and Shantou; or even part of a large city, such as Shanghai's Pudong district and Tianjin's Binhai's Newly Developed Area. Industrial and high-tech parks, on the other hand, are often part of a city or province and are not organized as separate administrative divisions. (ii) SEZs in the PRC tend to cover large geographic areas. Shenzhen, for instance, spans nearly 2,000 square kilometers (km); Shanghai's Pudong district is 522 square km; and Hainan, 34,000 square km. Industrial parks, however, rarely average more than 10 square km. (iii) A SEZ in the PRC is intended specifically as a pilot area in which comprehensive economic reforms can be carried out and the zone opened up to the rest of the world economy. It is thus mandated to experiment, and accorded the the right to experiment by the Central Government. This is equivalent to granting a SEZ a high degree of autonomy in implementing economic policies.

(iv) The PRCs SEZs are located in coastal areas with easy access to ports and transport networks. Moreover, they are specially set up in areas adjacent to the PRC's internationalized cities, economic hubs, or neighboring countries. Shenzhen borders Hong Kong, China; Zhuhai borders Macao; Xiamen adjoins Taipei,China; and the Tianjin Binhai Newly Developed Area borders Japan and the Republic of Korea. In contrast, the PRC's industrial parks are less bound by the geography of existing hubs and are located either in coastal areas or the interior provinces. (v) Finally, SEZs are subject to preferential policies on land, taxation, customs clearance, the use of foreign capital and profit repatriation by foreign investors, imports and exports, finance, and logistics. Such policies may be applied in many industrial parks following the practices of SEZs, but generally only after they have been tested in a SEZ. The subsequent sections use the Shenzhen SEZ as a case study to illustrate how preferential policies and the advantages of location have substantially improved its industrial competitiveness.

3. The Development of the Shenzhen SEZ

On 26 August 1980, as one of the important measures carried out to implement the PRC's new open door policy, the State Council of the PRC approved the establishment of the Shenzhen SEZ, making it the PRC's first SEZ since the country's independence in 1949. During the last few decades, Shenzhen has developed at a phenomenal pace, now famously referred to as Shenzhen speed. From 1980 to 2005, the average annual growth rate of the gross domestic product (GDP) of Shenzhen was 27%. This growth can be divided roughly into three stages: (i) from 1980 to 1986, which was characterized by an annual average growth rate of 44%; (ii) from 1987 to 1995, when GDP grew at an annual average rate of 29%; and (iii) from 1996 to 2003, when it grew at 19% annualy .The growth rate recorded in 2006 was 15%. To date, Shenzhen is still one of the largest and the most successful SEZs in the PRC. Shenzhen is located on the country's southern coast, adjacent to Dapeng Bay in the east, the Pearl River estuary in the west, and Hong Kong, China lying close to its southern perimeter. The total area of Shenzhen is about 2,000 square km and it has a population of about 12 million. Shenzhen consists of seven districts: Bao'an, Futian, Longgang, Luohu, Nanshan, Shekou, and Yantian. In 2006, Shenzhen's total GDP was $71.3 billion, ranking it fourth among the PRC's rapidly growing cities, and very close to the third-ranked city, Guangzhou. Shenzhen's GDP is expected to exceed that of Guangzhou in 2007; it is almost half that of Hong Kong, China. In 2006, Shenzhen's per capita GDP was ranked first in the country at more than $8,619 compared with the national average of about $2,0001. Shenzhen can thus
1

These figures are measured at current dollar prices.

be regarded as one of the richest cities in the PRC. Since 1979, Shenzhen's industrial base has continued to grow rapidly. The average annual growth rate of industrial valueadded was 40.2% between 1980 and 2004. In 2005, Its ratio of primary to secondary to tertiary industries was 0.2 : 53.2 : 46.6. The area's industrial structure has undergone three key transformations: (i) from traditional industry to hi-tech industry, (ii) from small-scale and scattered operations to large-scale and group-based companies, and (iii) from assembling and processing to independent manufacturing. This industrial structure is concentrated in certain sectors that account for large shares. In 2005, telecommunications, computers, and electronics accounted for almost 60% of the total industrial output in Shenzhen. Firms in Shenzhen have gradually established their own brand names. By the end of 2005, there were five Shenzhen brands with sales of more than Yuan10 billion (about $1.25 billion). Many well-known brands have emerged from the areas of telecommunications equipment, computer and related products, digital audio and video, flat panel display equipment, software, biomedicine, and the apparel sector. Huawei and Zhongxing, both large manufacturers of electronic and telecommunications equipment in Shenzhen, have become major suppliers in this sector not only in the PRC but also world wide. Since 1996, China International Marine Containers (Group) Ltd. has ranked first in terms of container output, accounting for more than 30% of the total share of the world market. The output of micro-motors accounts for about 10% of the world's total. Shenzhen remains an attractive destination for foreign investors. In 1979, the actual use of foreign capital amounted to $153.7 million; by 2006, it had reached $3.3 billion. International companies of office automation in Shenzhen

include Ricoh, Toshiba, Epson, Copier, and Xerox. Their Shenzhen plants generate a total output equivalent to about 21% of the world's total outputs by these companies. Other major investors include Wal-Mart, Compaq, Sony, Intel, IBM, and Siemens. In all, 141 of the world's top 500 multinational companies have currently invested in Shenzhen.

4. Factors Underpinning Shenzhen's Success

Many factors have contributed to the success and competitiveness of Shenzhen, some of which are discussed below. First, and most importantly, the Central Government has provided a special policy framework for the Shenzhen SEZ that has helped to create a soft enabling environment to enhance the city's industrial competitiveness. As a SEZ, Shenzhen has enjoyed by far the most liberal economic policies in the PRC, both in terms of attracting FDI and engaging in international trade. As a result, the actual utilization of FDI increased by 10% annually from 1980 to 2006, the value of exports reached $136.1 billion in 2006, while imports reached $101.7 billion. Shenzhen has been a testing ground for comprehensive reforms. For example, it was one of the first cities to apply differential corporate tax rates for foreign and domestic firms. While foreign investors paid a nominal tax burden of 15% and an actual tax burden of 11%, the corresponding figures for 2 domestic investors were 33% and 23%, respectively . In other words, the tax burden of domestic enterprises was twice that of foreign investors' enterprises. In 2007, the PRC carried out reforms to unify the two tax rates, which eliminated the preferential tax rate of 15% for most enterprises. However, this tax rate still applies to the hi-tech sector and small enterprises in the city. An open and liberal policy environment is the most important reason behind Shenzhen's success. Second, Shenzhen has been home to migrants from across the country and, more recently, from overseas. The innovative spirit of the city stems in part from its vibrant and strongly motivated migrant community. Migrants account for 83% of the
2

The actual tax rates take into account tax rebates, tax holidays, and other benefits provided to firms.

total population. Shenzhen's demographic profile favors economic development, given that permanent citizens under the age of 16 make up 21% of the population, 17- to 24 yearolds comprise 13% of the population, 25- to 44 years-old make up 49%, while people aged 60 and above account for less than 6% of the population, compared with the national average of 11%. Third, Shenzhen's enabling financial environment ensures that finance is available even for relatively risky ventures. This has been important for the city's industrial transformation, increasing its competitiveness. Indeed, Shenzhen is the PRC's most active city as far as the availability of venture capital is concerned. By the end of 2005, the number of venture capital firms in Shenzhen accounted for one third of the total number in the whole country. The city also houses the Shenzhen Stock Exchange, the Shenzhen Small and Medium Sized Enterprise Guarantee Center, and other critical financial architecture. Fourth, there is well established infrastructure in Shenzhen. Shenzhen's harbor ranks fourth in the global container transportation business, and Shenzhen's airport ranks third in PRC, with 18.4 million passengers in 2006. The supply and quality of other infrastructure, such as roads, telecommunications, and utilities, also rank highly in the PRC. All of these conditions have built a favorable logistic environment for the upgrading of industrial competitiveness in the city. Fifth, Shenzhen enjoys the advantage of location. As a coastal city bordering Hong Kong, China, Shenzhen's bid to upgrade its industrial structure and competitiveness has benefited hugely from its proximity to Hong Kong, China as a major international financial, information, and services center. A large share of investment to Shenzhen has come from Hong Kong, China, especially during the early years of Shenzhen's

development. Finally, the Shenzhen government is efficiently run, and apt to continuously reform and upgrade its administrative capacity. The government has provided convenient services, through direct one-stop services for large enterprises. Administrative transparency has improved over the years to strengthen the government's accountability. For instance, a development plan formulated by the Shenzhen government must be submitted to the People's Congress for approval. At the same time, local opinion is sought and encouraged to increase the transparency and effectiveness of the government decisionmaking process. Business procedures in Shenzhen are simple and streamlined. The Shenzhen government has also implemented personal service responsibility to ensure that firms' applications for various categories of government approval are processed within a specified period of time. Business approval procedures are currently under review and are expected to become even more business-friendly in the near future.

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5. Key Policies Contributing to Shenzhen's Industrial Competitiveness

One of the most important factors helping to facilitate Shenzhen's industrial transformation has been its ability to attract foreign investment, which undoubtedly lies behind much of the upgrading of the city's industrial structure and competitiveness. Output from foreign invested firms account for more than 40% of Shenzhen's GDP Over the last few . decades, FDI policies in the PRC, and especially in its SEZs, have become increasingly liberal. These include: (i) permission to set up wholly foreign-owned firms, (ii) enabling easier access to land and infrastructure, (iii) allowing the repatriation of profits, and (iv) favorable export and import polices. While FDI inflow was earlier concentrated in labor-intensive and small-scale operations, increasingly large multinational corporations from technology-intensive industries have begun to enter the PRC. To upgrade its industrial structure, the Shenzhen government has formulated a strategy to develop a headquarter economy by inviting multinational companies to move their headquarters into Shenzhen. This strategy consists of: (i) formulating systems to certify the headquarters of manufacturing companies, (ii) stipulating preferential measures to attract the headquarters of multinational corporations, and (iii) streamlining government procedures and enhancing government services for companies who choose to locate their headquarters in Shenzhen. Third, industrial parks are an integral component of the Shenzhen SEZ. There are about 100 industrial parks located in

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the city, more than 90% of these located outside Shenzhen checkpoint3, and about 70% based in villages and small towns. Shenzhen plans to integrate the existing parks and develop 52 larger parks. Fourth, Shenzhen encourages the formation of industrial clusters or concentrations to benefit from economies of scale and scope. Various industrial clusters have been formed in the city, including clusters for the garments, bicycles, furniture, and semi-conductor industries. All these clusters have gained substantially from economies of scale and scope. Fifth, in the last 3 years, in order to upgrade its industrial competitiveness, the Shenzhen Municipal Government has proposed policies to develop a recycling economy, with the aim of improving the city's environment and saving resources. On 16 March 2006, Shenzhen passed its Recycling Economy Promotion Rules, enforcing more than 10 key procedures and systems to assess a firm's mid and long-term performance and planning, and to provide government procurement and policy support for developing industries that are environmentally-friendly and energy-efficient. Sixth, in order to improve industrial competitiveness, the Shenzhen Government has decided to implement a new innovation strategy in early 2006. The aim is to structure Shenzhen as a National Innovative City in the PRC. Based on this decision, research and development investment will account for nearly 4% of the city's total GDP by 2010. The output value of high-tech products is expected to grow at an annual average rate of 20% over the next few years.
There are 9 checkpoints in Shenzhen. They were set up at the time when Shenzhen SEZ was established. The PRC Central Government gave Shenzhen a special policy to circle the area with wire to reduce the management pressure of the border, which was connected with Hong Kong, China. People who are not permanent citizens of Shenzhen must have a certification issued by the Police Bureau to enter Shenzhen. Since the space for development within the checkpoint, which is also where the city center is located, is quite limited, most of the industrial parks are set up outside.
3

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6 Conclusion
What can Pakistan learn from Shenzhen's experience of rapidly increasing its industrial competitiveness? Since the Industrial Revolution, economic development has been driven primarily by (i) industrialization, and (ii) urbanization. The development experience of Shenzhen shows that the development trajectory of developing economies also needs to proceed along this arc. In the late 1960s, Hong Kong, China; Singapore; the Republic of Korea; and Taipei,China made considerable progress in industrialization and urbanization. They serve as good examples and models demonstrating how industrialization and urbanization can act as catalysts for the process of economic development. A key factor in facilitating the industrialization and urbanization processes, however, is the provision of open and liberal economic policies. Industrialization and urbanization have taken place in the PRC in parallel with its transition from a planned to a market economy. A driving force in this transformation has been the implementation of economic reforms opening up the country to the world economy. In the process, the question of how to continually promote sustainable economic development and upgrade industrial structures in tandem with urbanization has become a significant issue for the whole country. From this perspective, Shenzhen's ability to undergo rapid industrialization and urbanization in a short span of time serves as an illuminating example, not only for PRC, but also for other developing countries. The experience of Shenzhen has also demonstrated the important difference between a SEZ and an industrial/hightech. The key point is that SEZs ultimately regenerate the

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unification of the industrialization and urbanization processes through comprehensive reforms. This is a critical lesson for Pakistan as it embarks on economic reforms and development. Too often policies of setting up isolated industrial parks lead to the development of enclaves that fail to propel sustainable economic growth. Shenzhen has the most open policy in the PRC for accommodating and attracting migrants from all over the country. It has also been open to foreign trade and foreign capital inflow, especially FDI. The openness to both financial and human capital has promoted fast economic growth. This, in turn, is beneficial for generating employment, improving people's livelihoods, and reducing poverty. In Shenzhen, the comprehensive reforms implemented in the SEZs by the Central Government have been supplemented by the local government's open and business-friendly policies, proving a powerful combination of forces driving economic growth and development.

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About the Asian Development Bank ADB is dedicated to reducing poverty in the Asia and Pacific region through pro-poor sustainable economic growth, social development, and good governance. Established in 1966, it is owned by 67 members - 48 from the region. With headquarters in Manila, ADB has 26 offices around the world and more than 2,000 staff from over 50 countries. In 2006, it approved loans and grants for projects totaling US$8.5 billion, and technical assistance amounting to almost US$242 million.

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