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The Rise of Special Economic Zones in Indonesia

Indonesia seeks to stimulate economic dynamism by attracting investment through its Special Economic Zones.

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Hailed as the largest economy in Southeast Asia (not by GDP per Capita measurement but overall), Indonesia has been one of the countries that have seemed to place their eggs in the SEZ basket. With 13 SEZs and more in the making, Indonesia has growing confidence in its potential to harness its abundant natural resources, alongside its financial sector, to ensure successful SEZ policies are implemented. 

What exactly are SEZs?

The ever-growing demand to draw investment into both developed and developing countries has been reflected in the adoption of many industrial policies where special regulatory regimes called Special Economic Zones (SEZs) have been implemented. 

According to the United Nations Conference on Trade and Development (UNCTAD) World Investment Report 2019, SEZs are specific geographically delimited areas within which governments facilitate industrial activities, through providing infrastructure support outside the zone, fiscal and regulatory incentives. 

Think special export processing zones, reliable infrastructure support, relief from customs duties and tariffs that promote a business-friendly environment – all constructed with the purpose of conveniently bringing multiple companies into one geographical location. 

The report also states that there are about 5,400 zones across 147 developed and developing economies globally, with more than 500 new SEZs to come. The SEZ boom is seen to be a part of a new wave of industrial policies undertaken and a response to increasing competition for internationally mobile investment. 

The historical trend in SEZs. | Photo Credit: UNCTAD

SEZs are where states aim to generate synergies, networks, and knowledge spillovers to foster additional economic activity in areas outside of the zones. In return for these concessions, governments expect the investment and businesses operating in the SEZs to create job opportunities, diversifying and boosting the productivity of the country’s economy. 

The beauty found in SEZs is that every SEZ has its own distinct regulatory regime. Even with the common goal to catalyse economic growth, they are subject to unique economic regulations in each area, showing that different approaches can be adopted with the same end in mind.

China has been one of the few successful countries leveraging these SEZs, and it also accounts for more than half of the world’s total SEZs. After decades of a centrally planned economy in China, the proliferation of SEZs has provided an opportunity to liberalise the state.

Indonesia’s high hopes for their SEZs

According to Bambang Wijanarko, Deputy Director for Development and Management Controlling of the Secretariat of the National Council for Special Economic Zone, the SEZs in Indonesia are aimed to stimulate economic growth throughout Indonesia, where there is uneven economic growth distribution in the country with growth concentrated on Java Island. 

The SEZ policies implemented in Indonesia have four main goals:

  1. To increase investment by providing competitive geo-strategic and geo-economic zones
  2. To accelerate equitable growth by establishing new economic growth centres in different regions in Indonesia
  3. To optimise industrial, export, import & other high-value economic activities
  4. To develop a new model of regional development that would increase job creation

Indonesia has high hopes for the SEZs, believing the particular incentives & multi-activity facilities designed will attract foreign investments and also generate positive performances on the surrounding regions outside of the SEZs.  

SEZ distribution map in Indonesia. | Photo Credit: Republic of Indonesia National Council for Special Economic Zone

The question now is, with the current 13 SEZs that Indonesia has developed in the pursuit of economic development, have they achieved their goals? 

There was a slow development pace of the SEZs, where the pressure to meet project target deadlines meant that these zones had limited designs and project management capabilities, where technical errors during constructions and inadequate preparation resulted in these zones being under-prepared. 

Of course, in such a competitive industry as the SEZs where there is always the emergence and promise of new zones, the poor structuring resulted in a lack of interest from investors despite all the proposed incentives set to attract them. The performance of many zones fell below expectations, failing to attract the significant investment they hoped to achieve. 

Indonesia’s Economic Affairs Minister Darmin Nasution stated that the realized investment in the country’s 13 SEZs totalled Rp 21 trillion (about US$1.5 billion), only about 25 per cent of the total investment commitment of Rp 85.3 trillion. 

Of the 33 Chinese companies that announced plans to set up or expand abroad from June to August last year, not one was planning to move to Indonesia. Unfortunately, much of the development costs that went into building the SEZs could not be recovered as it did not attract the anticipated influx of investors. Many of these SEZs remained underdeveloped for decades and remain underutilised.

What makes SEZs so unique?

The term ‘SEZ’ often encompasses different types of zones such as Free Trade Zone (FTZ) and Export Processing Zone (EPZ). Unlike FTZ and EPZ ─ which are similar in the way that they are mainly export-oriented ─ SEZ is an enclave of enterprises operating in a well-defined geographic area where certain economic activities are promoted by a set of policy measures that are not generally applicable to the rest of the country. 

Taxpayers conducting business in SEZs may enjoy tax facilities, and the business should cover the main activities determined for each SEZ based on the comparative advantage of the area. For instance, the Galang Batang SEZ in Bintan focuses on the bauxite-processing industry and logistics, while the Tanjung Kelayang SEZ in Belitung prioritises tourism. 

Bambang Wijanarko during the annual Asia Competitiveness Institute Conference last year stated that there can also be the development of several zones within the SEZs, like a tourism zone, export-processing zone and other economic activities. This model of regional development will give more authority to private enterprises to build their own business activities, he added. 

The SEZ policies offered a departure from the more rigid rules of FTZ and EPZ, as it adapted to the new demands of the industry while sustaining its basic charms to potential investors: business-friendly environments armed with incentives that were moulded to fit the unique activities that have been identified for each region. 

So, are SEZs actually worth it?

Whether SEZs have achieved their objectives is not entirely clear. The World Bank operational review of SEZs has shown that SEZs have the power to bring FDI and new businesses to regions and to boost exports, but it is still unclear if SEZs necessarily increase employment and achieve positive spillovers in the larger region. 

The review also recommends that SEZ policies should be developed while keeping in mind the precise social, political and legal contexts in which the zone operates. This means that even the geographical location of SEZs and their comparative advantage – as well as the supporting policies beyond the SEZ policy framework – matter. Furthermore, the success of the zones is dependent on factors within and outside of the zone, or in other words, how the SEZ program interacts with the strategic location it is in.

Despite these concerns regarding SEZs, new zones are still being developed in Indonesia, with more being proposed in Sumatra, Sulawesi and Java as governments remain competitive in this industry to emulate success stories. A new question also arises – will policymakers be able to balance creating successful SEZs while facing challenges brought about by the ever-changing dynamics of SEZs? 

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