What the U.S. Can Learn from the Success of China’s Special Economic Zones

Developed countries are struggling to tackle growing geographic inequality, a phenomenon fueling populism and discontent at the polls in Europe and the United States. In the face of economic change, large, globally connected cities have thrived, while many former industrial hubs have shrunk. Governments are now looking for ways to help these “left-behind” regions. Traditionally, policymakers in the West have relied on “people-based” methods to precisely target families facing economic hardship with cash or benefits like health insurance. But given the social unrest and deep inequality that still persist, some are now turning to place-based policies to spur job growth and investment in specific neighborhoods, municipalities, and regions.

A recent paper in the American Economic Journal from economists Yi Lu, Jin Wang, and Lianming Zhu examines perhaps the most ambitious attempt by a country at this type of policy: China’s Special Economic Zones (SEZs). As the Chinese government has transitioned from a centrally planned command economy to one with a much larger role for markets and private ownership, SEZs have been a cornerstone of its national development strategy. The hundreds of zones spread throughout China act as semi-autonomous economic clusters that sustain a mixture of private and state-supported businesses. With a goal of fostering growth and innovation, firms in Special Economic Zones receive a slew of financial benefits, including special corporate income tax rates, discounted land-use fees, and prioritized loan applications with domestic banks. Administrators grant larger benefits to exporters, firms with foreign investment, and technologically advanced companies.

Using a census of manufacturing firms taken both before and after the establishment of SEZs in the mid-2000s, the authors employ a series of statistical techniques to compare the outcomes in SEZs to nearby or similar areas that were not directly impacted by the policy. Lu, Wang, and Zhu find this round of SEZs generated significant positive effects on investment, employment, output, productivity, and wages when compared to similar non-designated municipalities. They calculate that increased corporate profits and wages exceeded foregone corporate tax revenue by roughly $16 billion. Moreover, the authors find that most of these gains came from new firms rather than the expansion of incumbent firms. These results suggest that SEZs generated new economic growth that exceeded their cost to the government.

Notably, the authors find that SEZ incentives provided a large boost to capital-intensive firms, or companies that invest more heavily in equipment and machinery than labor. Capital-intensive firms saw a nearly 11 percent increase in output compared to labor-intensive firms, and similarly larger increases in capital investment. These results can be traced to the program’s hefty subsidies for capital investments.

Negative spillovers have always been a concern for place-based incentives. It may be the case that incentives merely redirect economic activity from where it would have taken place to instead occur within the program’s boundaries. If true, this would mean the tax breaks don’t generate new investment and growth, but instead spark a zero-sum reshuffling of firms and jobs. However, the authors find no evidence of significant negative spillovers, implying that SEZs produced investment that otherwise would not have taken place.

There are notable differences between China’s SEZs and place-based industrial policy in the developed world. Traditional enterprise zones used by governments in the United States and United Kingdom typically work passively through the tax code, whereas China’s SEZs are effectively an entirely new economic regime. Each is managed by local administrators who have some degree of discretion over policy. Furthermore, enterprise zone incentives in the West tend to be neutral across industries, whereas SEZs heavily favor exporting and technologically advanced firms.

While there are significant and important differences between China’s SEZs and place-based policy in the developed world, there are lessons the United States and other developed countries can learn from their successes. For instance, rather than simply providing tax incentives to any firm that chooses to relocate or expand in struggling communities, these results suggest that governments utilizing place-based policy should instead focus on supporting capital-intensive firms and businesses that compete in global markets. If this productivity-focused strategy is transferable, it could go a long way in lifting up struggling regions and easing geographic inequality.

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Article source: Lu, Yi, Jin Wang, and Lianming Zhu. “Place-Based Policies, Creation, and Agglomeration Economies: Evidence from China’s Economic Zone Program.” American Economic Journal: Economic Policy 11, no. 3 (2019): 325–60.