Tuesday, March 27, 2012

A plea for Special Economic Zones (again...)

One of the themes since the beginning of this blog has been that Greece needs to use the instrument of Spezial Economic Zones (SEZ) in order to transform its economy. New liberalized laws & regulations alone won't do the trick in the short term because there is always resistance to mandated change. However, if people are shown alternatives which work well in practice, they will automatically want to copy them.

Greece ranks by far the lowest among EU-countries on the World Bank’s Doing Business 2012 Report (#100) and by far the highest on the TI’s Corruption Perception Index 2011 (#80). If Greece could be changed to rank among the top-ten in each of these reports, economic miracles would begin to happen there quickly.

There is NO WAY that one can change an entire country/society in a reasonably short time; at least not in a democracy. This is why I argue: "Don’t attempt to change the whole country in a short time because that won’t work anyway; instead, start with several 'pockets' (SEZs) which you structure in such a way that they are 'near-perfect' from day 1".

My role model is China. The old communists there realized that communism was not best answer for feeding one’s people on a sustained basis. They adhered to communism but they allowed several “pockets” where market mechanisms were put in place. And those initial pockets subsequently rubbed off on a much larger segment of Chinese society. And they are still communists…

Actually, I am not thinking of any special “perks” for the SEZs. Employees, companies and owners would be “perfect” tax payers. Unless you consider a liberalized business framework as a special perk (in present day's Greece you might have to...).

What would be offered to an investor in an SEZ? In general, pretty much everything that he would like to have. Specifically, no red tape in forming a company (for example: a one-stop office for all necessary permits and a 30-day turn-around); more or less free labor regulations; more or less free salary/wage negotiation between company and employees; guarantee of political risk for investments from abroad; etc. etc.

Now, let’s say I am a wealthy Greek with 50 MEUR in foreign bank accounts which yield me about 2% at the moment. For an attractive business opportunity in Greece, I would be willing to invest 5 MEUR out of those 50 MEUR. And, to use my favorite example, I see that all toothpaste in Greece is imported.

I educate myself how toothpaste is manufactured and I discover that one needs machines, ingredients and people for it. I do my math to figure out how much I can pay for machines, ingredients and people and still make a decent return on my investment (say 10%?). I don’t worry about market demand because I already know exactly how much that demand is (the amount of imported toothpaste).

Obviously, I will have to do my math in such a way that my price will be competitive with the price of imports. Even if it is, it might initially be difficult to get people to no longer buy imported toothpaste because they have gotten accustomed to it. So this is where I would ask the government for a perk: to temporarily apply a special tax to those imports so that people have an incentive to buy domestic toothpaste. I commit to the government that I will not “misuse” that temporary protection. In other words, I will hold on to my internationally competitive prices. And in a year or two, I ought to be able to get along without further protection.

The only one who loses in this game is the foreign exporter. But Greece is such a small market that losing it will not really harm any present exporter (and the exporter himself could opt to invest in domestic production!). Also, if things don’t change soon in Greece, the exporters to Greece may no longer want to export, anyway, for risk of not getting paid.

If I were a Greek politician, I would note the success of the new toothpaste company (less money spent for imports and new jobs, new personal and corporate taxes, and new taxes on dividends). I would ask for a list of other imports which could be substituted with domestic production the same way as the toothpaste example. And very soon there could be hundreds of new companies like the above.

If I were an unemployed Greek, I would try to get a job in the SEZ. I might get paid less than my friend at the National Railway but I know that my income will go up with productivity and not down because of austerity.

And finally: the Greeks outside the SEZ won’t be able to ignore that there are good things happening in the SEZ. In the beginning, the Greek political fundamentalists will brainwash them and explain that SEZs are nothing but sweat shops or exploitations of human beings. But when they see over time that the Greeks in the SEZs are happy campers who can steadily improve their living standard, they will undoubtedly begin asking why the whole country isn’t like an SEZ.

The beauty of import substitution is that it can be started literally overnight without any risk of insufficient market demand. Thus, SEZs lead to almost immediate improvement and they provide breathing space for the government to develop other economic activities which take time to implement and to find market demand (like new industries, etc.).

To sum up: if and when entire Greece becomes an SEZ as above, then Greece will have become a modernized country with a modern administration and a competitive business framework. But that takes a generation, at least!

Below is an excerpt from a previous post I had made on this subject.

A new Investment Law of constitutional rank must be established which assures the potential new investor all the internationally competitive business conditions which he desires. Since no one seems to trust any Greek law any more, the EU should guarantee compliance with this Investment Law so that investors do not have to carry any political risk (economic risk they have to carry!).

The investor would find an economic nirvana: he can produce competitively and he already has an assured market demand. And he is covered against all sorts of Greek political risk.

Wealthy Greeks hold hundreds of billion Euros in foreign bank accounts. The new Investment Law must aim at the voluntary return to Greece for new investment of parts of those funds. Greeks are good businessmen and they recognize a good business opportunity quickly. Why should wealthy Greeks prefer to earn 2% in Switzerland when they could earn a multiple thereof in Greece with the same security?

Why selective Special Economic Zones and not the whole country to begin with? Because one cannot restructure a country’s economy from A-Z at one and the same time; that would lead to a revolution. Instead, the objective has to be to make the Special Economic Zones work well and to hope that their economic framework will rub off on the rest of the economy over the years.

Of foremost priority is good business governance in the Special Economic Zones; everything must be on correct and transparent footing. If the Greek way of doing business (tax cheating, corruption) set foot in the Special Economic Zones, the project would be doomed from the start. There would have to be efficient control mechanisms such as regular audits by reputable auditing firms. Perhaps even periodic EU-inspections (after all, they guarantee compliance with the Investment Law).

The great risk associated with import controls is always that this protection of the domestic economy is misused by domestic manufacturers. Suppose an imported tooth paste costs 1 EUR per tube and the new internationally competitive conditions in the Special Economic Zones allow the domestic manufacturer to also operate profitably at that price. Assume further that a 100% special tax will temporarily be imposed on the imported tooth paste so that the domestic manufacturer can start up his business. Thus, the imported tube will now cost 2 EUR. The risk is that the clever Greek businessman may now want to sell the domestically manufactured tube at 1,99 EUR.

This is not how the system can work! The objective of the Special Economic Zones is to build up sustained domestic manufacturing. They cannot be misused by clever Greek businessmen to produce competitively but sell at twice the price. The benchmark always has to be the international price!

All of this sounds very much like a planned economy, but it isn’t. It all depends on the new Investment Law is formulated. The law has to establish firmly those rules within which entrepreneurs can act freely and to their profit. An effective Investment Law will offer the investor an attractive relationship between security, risk and reward. If that is accomplished, the investors will come on their own.

Chile showed in the late 1970s how a good Foreign Investment Law turned a formerly communist and planned economy in a short time into the „darling“ of foreign investors. Why should Greece not be able to accomplish the same? (particularly with the EU-guarantee, of which Chile had no equivalent).

Argentina has attempted several economic stabilization plans over the decades and for a limited period of time they all seemed to work. The foreign money of Argentines always returned quickly to the country and accelerated the recovery. However, as soon as the first clouds appeared on the economic horizon, that money left the country as quickly as it had come. Greece must accomplish the “trick” to create the kind of economic framework so that the foreign financial assets of Greeks stay in the country on a sustained basis.

The government must assure that many investment opportunities are always on offer for investors. They must be well presented and accompanied by base case business plans, and they must be publicly tendered. The government could even involve some PR-coverage to stimulate a “run” on such new investments (based on the theme: “let’s get in before the door perhaps closes again”).

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