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India's pockets of prosperity?

Special Economic Zones are attractive on paper. But they pose thorny political problems.

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Imagine that the US government designated Long Island a Special Economic Zone (SEZ). Firms could operate there with tax exemptions, minimal red tape, no tariffs on imported inputs, and superior infrastructure.

Many firms would want to locate there, boosting industrial activity, exports, and jobs. But would Long Islanders benefit? Would they be willing to sell their land to firms? What if the government acquired the land on behalf of the firms?

In India, these questions aren't hypothetical – they have become thorny political problems.

India enacted an SEZ Act in 2005, hoping to boost infrastructure, promote investments, attract foreign firms, create industrial clusters, and increase exports while creating jobs.

SEZs are not novel: Previous incarnations, such as free-trade zones, have had a mixed record worldwide. But perhaps due to China's rapid growth, developing nations have taken a second look.

In 2007, China attracted $84 billion in foreign direct investment (FDI), mostly through its SEZs. India had only $23 billion in FDI and a large trade deficit, so SEZs became a key part of its development strategy.

That policy has become a magnet for criticism. The preferential treatment given to SEZ firms is being challenged by a case filed in Indian courts, alleging the SEZ policy to be "discriminatory" and "arbitrary."

Favors to SEZ firms also raise other concerns. For instance, would these advantaged firms withstand global competition once tax breaks were removed? How much employment would these zones generate? Should a government with a growing budget deficit grant five-year tax exemptions? All nations that have tried SEZs have had to deal with these trade-offs. In India, however, these concerns have been trumped by a bigger issue: land.

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