Opinion|Reimagining SEZs to Drive Economic Competitiveness

In the recent Budget, the Finance Minister Nirmala Sitharaman announced a significant initiative aimed at creating “employment, skilling and other opportunities for 4.1 crore youth over a 5-year period with an outlay of 2 Lakh crore”.  The strategy focuses on revitalising the manufacturing sector, especially in labour-intensive areas. And while the Budget talks about different incentives the government aims to give to enable manufacturing, it is silent on reforms that can improve firm competitiveness.

Manufacturing in India faces multiple challenges such as restrictive labour laws, inefficient land utilisation, stringent environment regulation among others. Without addressing these issues to enhance global competitiveness, India cannot achieve the ambitious job creation targets outlined in the Budget.

A proven strategy for achieving global cost competitiveness is concentrating reform efforts in large industrial regions. China's special economic zones (SEZs), particularly Shenzhen, are celebrated examples of how region-level reforms can lead to long-term economic prosperity. In contrast, India’s SEZs have not met similar success. India’s 280 operational SEZs account for $163bn in exports, approximately 60 per cent of which are service exports, and provide employment to 3mn people. By comparison, Shenzhen alone generates twice the export value and four times the employment.

This is because while China used its SEZs as regulatory sandboxes to drive competitiveness, SEZs in India offered no differential regulatory or governance benefits, focusing instead on tax and tariff benefits which were also quickly taken away. SEZs in China were used to facilitate rapid experimentation in reforms related to land use, pricing systems, labour markets, financial systems and privatisation. The Chinese granted legislative power to the Shenzhen SEZ, enabling swift policy action and incentive alignment at the local level. These reforms, coupled with tax breaks and reduced tariffs, attracted foreign companies and fostered joint ventures, fueling long-term prosperity.

In India, SEZs largely failed to deliver distinct regulatory or governance advantages, becoming vehicles for tax arbitrage rather than engines of growth. A closer examination of SEZ exports from FY06 to FY22 underscores this reality: Exports surged by 62 per cent between 2006 and 2012, while the rest of the country saw only a 15 per cent increase. However, when the 2012 Finance Bill curtailed these tax incentives, export growth in SEZs dropped sharply to 8 per cent, nearly converging with the national average of 6 per cent.

Furthermore, the SEZ Act prevented manufacturers within these zones from competing effectively in the domestic market. Thus, despite the initial optimism surrounding the SEZ initiative, it failed to address the underlying cost challenges of manufacturing in India. Although tax breaks temporarily alleviated these pressures, the removal of incentives led to stagnation in both manufacturing and export growth. 

But as we aim to enable labour intensive manufacturing in India, we have an opportunity to revitalise our SEZs as regulatory sandboxes that can boost manufacturing. The concept of using SEZs to provide a globally competitive regulatory regime is not new for India. In 2020, the Government of India established the International Financial Services Centres Authority (IFSCA) in GIFT city by enacting the IFSCA Act of 2019.

This act transferred powers from regulators like RBI, Sebi and IRDA to an IFSCA, consolidating and streamlining the regulatory framework for financial services. Today GIFT city aims to compete with Mumbai, Shanghai and London, and our recent visit confirms that they are well underway to achieving this vision in the coming decades.

All we need is to expand on this approach and offer a globally competitive playing field to our manufacturers. For example, restrictive labour laws are widely recognised as a key reason for lack of competitiveness. While the new labour codes are trying to ease certain restrictions, they have yet to be implemented as governments (Centre and state) are worried about the political implications of such legislation.

However, politically it will be a lot easier to make changes at a relatively small scale instead of country- or state-wide, since existing entrenched interests will not be threatened as much. So, a simple amendment to Section 49(1) of the SEZ Act that allows SEZs to have differential labour regulations, can help not only pressure test reforms but more importantly unlock millions of jobs.  

India’s SEZ initiative, though initially promising, fell short due to ineffective implementation and policy shifts. By adopting lessons from successful SEZs globally and enacting targeted reforms, India can still convert its SEZs into dynamic industrial hubs. This transformation will support a robust, sustainable and inclusive industrial future, fostering long-term prosperity and resilience for the nation.  

(Rahul Ahluwalia is the co-founder and Ronak Pol is the team lead strategy of The Foundation for Economic Development. Views expressed are personal.)