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7 Reasons Not to Set Up Your Business in a Special Economic Zone

Greg de la Cruz works at NCR Corp's R&D center in the Philippines. He is interested in economic history and current world financial affairs.

The Shenzhen Special Economic Zone was established in 1980 and was one of the first-ever ecozones in China. From a population of just 59,000 in 1980, Shenzhen is now home to over 12 million people, making it China's third most populous city.

The Shenzhen Special Economic Zone was established in 1980 and was one of the first-ever ecozones in China. From a population of just 59,000 in 1980, Shenzhen is now home to over 12 million people, making it China's third most populous city.

What Is a Special Economic Zone?

A special economic zone, or an ecozone, is a selected area that's highly developed or has the potential to be developed into an agro-industrial, industrial, tourist/recreational, commercial, banking, investment, or financial center (The Philippines’ Special Economic Zone Act of 1995).

Ecozones are special areas within a country or state that enjoy incentives, such as tax breaks, a relaxation of regulations, or are simply considered as separate customs territories. They are intended to promote investment and job generation, especially from foreign companies, which are usually looking for ways to outsource sections of their business operations as a means to cut down on costs.

As great as the idea may seem, there are also hidden costs of a government creating ecozones (such as land-grabbing and environmental degradation) that don’t get enough attention, because an administration’s priority of attracting business often outweighs societal implications.

Special economic zones operate on the premise of the ease of doing business, whether that’s to create a nearly laissez-faire atmosphere or by simply reducing the cost of doing business. The Philippines, for example, enacted the Special Economic Zone Act of 1995 (R.A. No. 7916), which created the Philippine Economic Zone Authority (PEZA).

Businesses that register their business activities with PEZA or operate inside an ecozone are normally entitled to an income tax holiday for the first few years and enjoy the lower rate of 5 percent income tax after that—compared to other ordinary businesses, which must remit 25 percent income tax.

But ahead of the rest of the world in creating ecozones inside their country was China, which in the 1980s “opened up” to the rest of the world. Coastal cities—Shenzhen, Zhuhai, Shantou, and Xiamen—were the first of many such regions that China turned into ecozones.

In 1984, China created 14 more ecozones by opening 14 more coastal cities to overseas investment. According to FDI China, as of October 2020, there are more than 20 ecozones in state-level areas, at least seven specific SEZs, 10 pilot free-trade zones, and 16 coastal open cities—for a grand total of 168 “high-tech industrial development zones.”

Although India was late to the game when it enacted its first SEZ policy in 2000, it is already home to 238 SEZs. And the Philippines, which started establishing ecozones in 1995, already had as many as 277 by the year 2012.

Just how much do ecozones contribute to a country’s economy? For China, nearly a quarter of its GDP is derived from SEZs; for India, nearly a fifth, and the Philippines also a fifth.

Special economic zones have become so popular in recent years that a 2019 report by the United Nations Conference on Trade and Development (UNCTAD) showed that in 2018, a total of 147 countries had established SEZs, from just 29 countries in 1975.

7 Reasons Not to Set Up Your Business in a Special Economic Zone in the Philippines

Despite the many clear advantages of setting up one’s business inside a special economic zone, there are also drawbacks.

Aside from potentially being in a compromised position depending on an administration’s whim, there are many such unseen disadvantages for businesses who choose to set up operations in an ecozone. Here are seven reasons not to set up your business in a special economic zone.

  1. More Bureaucracy Than Expected
  2. Interference by the Government on Work Arrangements
  3. Lock-in Periods and Restrictions
  4. Closer Scrutiny by Authorities
  5. Corruption From Customs Officials
  6. Employee Housing Problems
  7. Social Costs

1. More Bureaucracy Than Expected

So much for the “ease of doing business”—special economic zone authorities such as PEZA are notorious for burdensome requirements on anything done within the ecozone or for activities having to do with moving things in and out of ecozones. Because ecozones afford businesses with so much deregulation, the corresponding result has been the rise in illicit activities done within these special borders.

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Money laundering, human trafficking, and environmental exploitation were very common early on because of a government’s laissez-faire attitude, and due to this hands-off culture, bureaucracy eventually gained momentum. Paranoid that these SEZs would be used to create weapons of mass destruction, authorities started requiring documentation and permits for when a company ships items in and out of ecozones.

The so-called “express lane,” which used to make things easy for manufacturing and engineering firms to import and export specific materials, is now accompanied by piles of reports and supporting documents, along with an authorization request addressed to ecozone administrators, which, because of the multitude of ecozone enterprises that have popped up, can take months to get approved or even looked at.

There’s so much bureaucracy inside ecozones and hidden fees that business leaders sometimes contemplate whether the registration as an SEZ enterprise was even worth it.

2. Interference by the Government on Work Arrangements

Did you ever think that a government could prevent certain companies from working from home or even doing hybrid?

That’s exactly what happened in the Philippines when, by virtue of the CREATE Act of 2021 (which was supposed to attract foreign investors), companies that enjoyed fiscal incentives from investment promotion agencies such as PEZA were only allowed to conduct their operations exclusively within the borders of their economic zone.

This meant that a hybrid workstyle, which allowed employees to work from home, was prohibited for a company that registered its business with an economic zone authority. In short, businesses within PEZA zones were forced to bring their entire workforce back into the office—no exceptions.

The CREATE Act has seemingly backfired in the sense that foreign companies—most of which have accepted the hybrid workstyle as the new normal—are instead hesitating to set up shop in the Philippines or are reluctant to add to their existing workforce, not wanting to implement a pre-pandemic fully onsite work arrangement.

3. Lock-in Periods and Restrictions

A 2019 UNCTAD report highlighted the importance of ecozones in facilitating the entry of new business into a country. “In return,” the report said, “for these customs, fiscal and regulatory concessions; business-support measures; and investments in physical infrastructure, governments expect investors operating in SEZs to create jobs, boost export, diversify the economy and build productive capacity.”

This expectation coming from government authorities isn’t a simple handshake agreement. It’s usually a registration agreement containing essential terms such as the amount of owned or leased area by the company, how much sales or revenue it should generate, and sometimes how many people it should employ.

Not only that, there’s sometimes a “lock-in period” created so that the company can’t jump ship after one or two profitable years. Governments sometimes create a lock-in period by implementing a full tax break for a set number of years, but sometimes the lock-in period can come in the form of penalties and the revocation of the company’s registration.

4. Closer Scrutiny by Authorities

If you think that you can let shady operations slip by within special economic zones, think again. There’s so much scrutiny from authorities upon a company’s operation that almost every small move a company makes that involves the transferring of assets results in a requisite inspection by these authorities.

This system has constructively turned into an automated search warrant system, where you simply can’t hide anything—and anything that authorities find that’s not legal or compliant will be met with serious consequences.

Special economic zones are ordinarily considered separate customs territories since the import-and-export activities usually enjoy zero-to-minimal tax and duties. Because of the latter, authorities need to ensure that what’s being moved in and out is associated with what the business is legally allowed to do.

Hence, you’d be wrong in saying that ecozone officials don’t sniff around—because the right assumption would be that these officials now know what to sniff for, so beware.

5. Corruption From Customs Officials

Speaking of sniffing around, you should also be wary of people from the government who have a twisted sense of smell, or more specifically, public officials who will take every opportunity to squeeze what they can from day-to-day transactions.

During the 2022 presidential debates for the Philippines, which were held by various media outlets, a subject that came up a lot dealt with the question, “Should you become president, which government agency would you investigate first for corruption?” And the overwhelming answer was the Bureau of Customs (BOC).

This is not to say that every employee and official coming from the BOC was corrupt—this is certainly never the case—but some bad apples of the government without a doubt come from customs officials. When you set up your business inside a special economic zone, your assumption might be that this is where government is the least corrupt, since there are supposedly fewer layers of red tape.

Unfortunately, this may not always be the case, as customs officials could take advantage of you and either make transactions extremely difficult or exact higher duties and taxes than what should be levied.

6. Employee Housing Problems

Job generation is one of the main goals of a government when setting up ecozones, and access to a large pool of workers is the corresponding benefit given to businesses that set up shop. People from neighboring provinces and non-industrial regions tend to flock to the region or city with a special economic zone in the hopes of getting a job and landing one that pays well.

What’s the flipside to this sharp increase in jobs, you might ask? Employee housing problems. The supply of affordable housing to workers most of the time simply cannot catch up with the demand. Some companies cope with this by integrating dormitories within their offices or plants—some even construct their buildings in such a way that a portion of it is for production and a smaller portion for stacked box apartments.

Some companies take advantage of the lack of nearby housing by building or buying residential real estate and even retail establishments, effectively taking back the wages that they paid to their workers.

In a way, people from the provinces are lured into these special economic zones with the promise of a better life and the prospect of a “career” when in reality, they’re more likely to be in a position where they barely make ends meet.

7. Social Costs

Last but not least—the social costs. Because governments find it so appealing to turn both idle and agricultural land into industrial zones, attention to the social impact of creating special economic zones has not been given due.

Hence, if you are a business setting up your operations within an ecozone, you might as well be effectively aiding and abetting the social crime committed by the government—destroying forests, stealing land from farmers, washing away a people’s culture—all in the name of more money.

Not to mention that companies inside SEZs are notorious for being anti-union and can escape any predicament by threatening to leave or by simply reorganizing somewhere else. There are labor issues that don’t get enough attention inside SEZs, and that’s probably a good topic for another article.

Do the Costs Outweigh the Benefits?

The true negative impact of special economic zones on both businesses and governments is yet to be widely exposed. Global reform is already taking place, with countries coming together to create a universal minimum rate for tax breaks and the like.

But with the number of special economic zones continuing to increase every year, it seems that businesses and governments alike are willing to absorb any and all costs to society for the sake of profit.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

© 2022 Greg de la Cruz

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