November 2007

PRM Policy NoteSeries No. 2Pakistan Resident Mission

Special Economic Zones and CompetitivenessA Case Study of Shenzhen, the People's Republic of China

Wanda Guo and Yueqiu Feng

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The PRM Policy Note Series is based on papers and notes prepared by PRM staff and resource persons. The series is designed to provide concise non-technical accounts of issues of policy importance to Pakistan. Feedback is welcome via e-mail (adbprm@adb.org).

PRM welcomes submission of brief papers from both ADB staff and external contributors for the PRM Policy Note Series. The papers can be submitted to Ms. Emma Xiaoqin Fan (xfan@adb.org) and Mr. Khurram Butt (kbutt@adb.org).

The views expressed in the series are those of the authors and do not necessarily reflect the views or policies of the ADB.

Pakistan Resident MissionAsian Development Bank1st Floor, OPF BuildingSharah-i-Jamhuriyat, G 5/2Islamabad. Pakistan© 2007

PRM Policy Note Series Review Committee

Chair:Peter L. Fedon, Country Director, Pakistan Resident MissionAsian Development Bank

Members:Emma Xiaoqin Fan, Senior Public Resource Management SpecialistSafdar Parvez, Economist

Coordinator: Khurram Butt

PRM Policy NoteSeries No. 2Pakistan’s Resident Mission

Dr. Wanda Guo is vice-president of the China Development Institute (CDI), and Ms Yueqiu Feng is director of the CDI's International Cooperation Department. This paper was presented at the Pakistan Development Forum in April 2007. The authors thank Peter L. Fedon, Emma Xiaoqin Fan, and Safdar Parvez for comments and suggestions; Maheen Pracha for copy editing; and Khurram Butt for coordinating the publication of this issue.

November 2007

Wanda Guo and Yueqiu Feng

www.adb.org/prm/publications.asp

Special Economic Zones and CompetitivenessA Case Study of Shenzhen, the People's Republic of China

Contents

Abbreviations

1 Introduction 1

2 SEZs compared to Industrial/High-Tech Parks 3

3 The Development of the Shenzhen SEZ 5

4 Factors Underpinning Shenzhen's Success 7

5 Key Policies Contributing to Shenzhen's Industrial Competitiveness 9

6 Conclusion 11

ADB Asian Development Bank

FDI foreign direct investment

GDP gross domestic product

PRC People's Republic of China

PRM Pakistan Resident Mission

SEZ special economic zone

Abbreviations

(i) In this paper, "$" refers to US dollars.

1

1. Introduction

Special economic zones (SEZs) have played an important role

in advancing economic reform in the People's Republic of

China (PRC) and, particularly, in opening up its economy to the

rest of the world. The Shenzhen SEZ was the first SEZ to be set

up in the PRC. Over the past few decades, Shenzhen has

developed from being a small fishing village in Guangdong

Province into a major industrial and financial center, benefiting

substantially from the liberal economic policies granted by the

Central Government to SEZs. Shenzhen's rapid development

has showcased the advantages of “open door” policies and

market-oriented reforms, served as a “laboratory” for piloting

policies, and propelled economic development in the rest of

the country.

This policy note briefly documents the experience of Shenzhen

and analyzes the factors that have contributed to its

emergence as a successful SEZ. There are useful lessons to

be drawn from Shenzhen's experience by countries such as

Pakistan in designing their economic reform policies. The

major findings of this policy brief are summarized below.

The experience of Shenzhen has demonstrated the important

differences between a “special economic zone” and an

“industrial/high-tech park.” A SEZ is a comprehensive

laboratory in which fully fledged economic reforms can be

piloted, while industrial parks are a supporting component of

SEZs, but with an industrial focus. SEZs in the PRC are

authorized by the Central Government and cover large

administrative areas such as an entire province or a city. In

contrast, industrial parks are authorized by provincial and

municipal governments, and generally encompass only part of

a city. There are over 1,500 industrial parks in the PRC, but only

7 SEZs. In this sense, few countries in the world have SEZs,

while most have industrial parks. Too often policies of setting

up isolated industrial parks lead to the development of

enclaves which are unable to propel sustained economic

growth. Given the importance of SEZs in testing and

showcasing the success of economic reforms, the PRC's

experience on SEZs sheds light on the concept and potential

of SEZs for other developing countries.

The success of Shenzhen further demonstrates the

importance of an enabling policy environment. In particular,

Shenzhen's experience indicates the benefits of open and

market oriented economic polices. Indeed, Shenzhen has

enjoyed by far the most open and market-oriented economic

policies in the PRC. This has attracted not only young and

skilled migrants from across the country, but also large inflows

of foreign direct investment (FDI), transforming a small village

into a financial and industrial hub. This openness to both

financial and human capital has promoted fast economic

growth, which has, in turn, been beneficial for generating

employment, improving people's livelihoods, and reducing

poverty.

Shenzhen serves as a good example of how industrialization

and urbanization can act as catalysts for economic

development. By implementing comprehensive economic

reforms, SEZs ultimately unify the industrialization and

urbanization processes.

2

2. SEZs compared to Industrial/High-Tech Parks

SEZs were established in the PRC as early as 1980. The

Central Government has so far only authorized seven SEZs.

These are occasionally referred to as the ”4+2+1,” where (i)

”4” refers to the first group of SEZs that were authorized in

1980-Shenzhen, Zhuhai, Xiamen, and Shantou; (ii) ”2“ refers to

the new Pudong district in Shanghai and Hainan province,

both authorized as SEZs in 1990; and (iii) ”1“ refers to the

Newly Developed Area of Tianjin Binhai, which was authorized

in 2006.

The key differences between SEZs and industrial/high-tech

parks are outlined below.

(i) Essentially, a SEZ is an administrative division: it can span

an entire province, such as Hainan; entire cities, such as

Shenzhen, Zhuhai, Xiamen, and Shantou; or even part of a

large city, such as Shanghai's Pudong district and Tianjin's

Binhai's Newly Developed Area. Industrial and high-tech

parks, on the other hand, are often part of a city or province

and are not organized as separate administrative

divisions.

(ii) SEZs in the PRC tend to cover large geographic areas.

Shenzhen, for instance, spans nearly 2,000 square

kilometers (km); Shanghai's Pudong district is 522 square

km; and Hainan, 34,000 square km. Industrial parks,

however, rarely average more than 10 square km.

(iii) A SEZ in the PRC is intended specifically as a pilot area in

which comprehensive economic reforms can be carried

out and the zone opened up to the rest of the world

economy. It is thus mandated to “experiment,” and

accorded the ”the right to experiment” by the Central

Government. This is equivalent to granting a SEZ a high

degree of autonomy in implementing economic policies.

3

(iv) The PRC’s SEZs are located in coastal areas with easy

access to ports and transport networks. Moreover, they

are specially set up in areas adjacent to the PRC's

“internationalized” cities, economic hubs, or neighboring

countries. Shenzhen borders Hong Kong, China; Zhuhai

borders Macao; Xiamen adjoins Taipei,China; and the

Tianjin Binhai Newly Developed Area borders Japan and

the Republic of Korea. In contrast, the PRC's industrial

parks are less bound by the geography of existing hubs

and are located either in coastal areas or the interior

provinces.

(v) Finally, SEZs are subject to “preferential policies” on land,

taxation, customs clearance, the use of foreign capital and

profit repatriation by foreign investors, imports and

exports, finance, and logistics. Such policies may be

applied in many industrial parks following the practices of

SEZs, but generally only after they have been “tested” in a

SEZ.

The subsequent sections use the Shenzhen SEZ as a case

study to illustrate how preferential policies and the advantages

of location have substantially improved its industrial

competitiveness.

4

3. The Development of the Shenzhen SEZ

On 26 August 1980, as one of the important measures carried

out to implement the PRC's new “open door” policy, the State

Council of the PRC approved the establishment of the

Shenzhen SEZ, making it the PRC's first SEZ since the

country's independence in 1949. During the last few decades,

Shenzhen has developed at a phenomenal pace, now

famously referred to as “Shenzhen speed.” From 1980 to 2005,

the average annual growth rate of the gross domestic product

(GDP) of Shenzhen was 27%. This growth can be divided

roughly into three stages: (i) from 1980 to 1986, which was

characterized by an annual average growth rate of 44%; (ii)

from 1987 to 1995, when GDP grew at an annual average rate

of 29%; and (iii) from 1996 to 2003, when it grew at 19%

annualy .The growth rate recorded in 2006 was 15%. To date,

Shenzhen is still one of the largest and the most successful

SEZs in the PRC.

Shenzhen is located on the country's southern coast, adjacent

to Dapeng Bay in the east, the Pearl River estuary in the west,

and Hong Kong, China lying close to its southern perimeter.

The total area of Shenzhen is about 2,000 square km and it has

a population of about 12 million. Shenzhen consists of seven

districts: Bao'an, Futian, Longgang, Luohu, Nanshan, Shekou,

and Yantian.

In 2006, Shenzhen's total GDP was $71.3 billion, ranking it

fourth among the PRC's rapidly growing cities, and very close

to the third-ranked city, Guangzhou. Shenzhen's GDP is

expected to exceed that of Guangzhou in 2007; it is almost half

that of Hong Kong, China. In 2006, Shenzhen's per capita GDP

was ranked first in the country at more than $8,619 compared 1with the national average of about $2,000 . Shenzhen can thus

5

1 These figures are measured at current dollar prices.

be regarded as one of the richest cities in the PRC.

Since 1979, Shenzhen's industrial base has continued to grow

rapidly. The average annual growth rate of industrial value-

added was 40.2% between 1980 and 2004. In 2005, Its ratio of

primary to secondary to tertiary industries was 0.2 : 53.2 : 46.6.

The area's industrial structure has undergone three key

transformations: (i) from traditional industry to hi-tech industry,

(ii) from small-scale and scattered operations to large-scale

and group-based companies, and (iii) from assembling and

processing to independent manufacturing. This industrial

structure is concentrated in certain sectors that account for

large shares. In 2005, telecommunications, computers, and

electronics accounted for almost 60% of the total industrial

output in Shenzhen.

Firms in Shenzhen have gradually established their own brand

names. By the end of 2005, there were five Shenzhen brands

with sales of more than Yuan10 billion (about $1.25 billion).

Many well-known brands have emerged from the areas of

telecommunications equipment, computer and related

products, digital audio and video, flat panel display

equipment, software, biomedicine, and the apparel sector.

Huawei and Zhongxing, both large manufacturers of electronic

and telecommunications equipment in Shenzhen, have

become major suppliers in this sector not only in the PRC but

also world wide. Since 1996, China International Marine

Containers (Group) Ltd. has ranked first in terms of container

output, accounting for more than 30% of the total share of the

world market. The output of micro-motors accounts for about

10% of the world's total.

Shenzhen remains an attractive destination for foreign

investors. In 1979, the actual use of foreign capital amounted

to $153.7 million; by 2006, it had reached $3.3 billion.

International companies of office automation in Shenzhen

6

include Ricoh, Toshiba, Epson, Copier, and Xerox. Their

“Shenzhen plants” generate a total output equivalent to about

21% of the world's total outputs by these companies. Other

major investors include Wal-Mart, Compaq, Sony, Intel, IBM,

and Siemens. In all, 141 of the world's top 500 multinational

companies have currently invested in Shenzhen.

7

4. Factors Underpinning Shenzhen's Success

Many factors have contributed to the success and

competitiveness of Shenzhen, some of which are discussed

below.

First, and most importantly, the Central Government has

provided a special policy framework for the Shenzhen SEZ that

has helped to create a “soft enabling environment” to enhance

the city's industrial competitiveness. As a SEZ, Shenzhen has

enjoyed by far the most liberal economic policies in the PRC,

both in terms of attracting FDI and engaging in international

trade. As a result, the actual utilization of FDI increased by 10%

annually from 1980 to 2006, the value of exports reached

$136.1 billion in 2006, while imports reached $101.7 billion.

Shenzhen has been a testing ground for comprehensive

reforms. For example, it was one of the first cities to apply

differential corporate tax rates for foreign and domestic firms.

While foreign investors paid a nominal tax burden of 15% and

an actual tax burden of 11%, the corresponding figures for 2

domestic investors were 33% and 23%, respectively . In other

words, the tax burden of domestic enterprises was twice that of

foreign investors' enterprises. In 2007, the PRC carried out

reforms to unify the two tax rates, which eliminated the

preferential tax rate of 15% for most enterprises. However, this

tax rate still applies to the hi-tech sector and small enterprises

in the city. An open and liberal policy environment is the most

important reason behind Shenzhen's success.

Second, Shenzhen has been home to migrants from across

the country and, more recently, from overseas. The innovative

spirit of the city stems in part from its vibrant and strongly

motivated migrant community. Migrants account for 83% of the

8

2 The actual tax rates take into account tax rebates, tax holidays, and other benefits provided to firms.

total population. Shenzhen's demographic profile favors

economic development, given that permanent citizens under

the age of 16 make up 21% of the population, 17- to 24 year-

olds comprise 13% of the population, 25- to 44 years-old make

up 49%, while people aged 60 and above account for less than

6% of the population, compared with the national average of

11%.

Third, Shenzhen's enabling financial environment ensures that

finance is available even for relatively risky ventures. This has

been important for the city's industrial transformation,

increasing its competitiveness. Indeed, Shenzhen is the PRC's

most active city as far as the availability of venture capital is

concerned. By the end of 2005, the number of venture capital

firms in Shenzhen accounted for one third of the total number

in the whole country. The city also houses the Shenzhen Stock

Exchange, the Shenzhen Small and Medium Sized Enterprise

Guarantee Center, and other critical financial architecture.

Fourth, there is well established infrastructure in Shenzhen.

Shenzhen's harbor ranks fourth in the global container

transportation business, and Shenzhen's airport ranks third in

PRC, with 18.4 million passengers in 2006. The supply and

qual i ty of other infrastructure, such as roads,

telecommunications, and utilities, also rank highly in the PRC. All

of these conditions have built a favorable logistic environment for

the upgrading of industrial competitiveness in the city.

Fifth, Shenzhen enjoys the advantage of location. As a coastal

city bordering Hong Kong, China, Shenzhen's bid to upgrade

its industrial structure and competitiveness has benefited

hugely from its proximity to Hong Kong, China as a major

international financial, information, and services center. A large

share of investment to Shenzhen has come from Hong Kong,

China, especially during the early years of Shenzhen's

9

development.

Finally, the Shenzhen government is efficiently run, and apt to

continuously reform and upgrade its administrative capacity.

The government has provided “convenient services,” through

direct one-stop services for large enterprises. Administrative

transparency has improved over the years to strengthen the

government's accountability. For instance, a development plan

formulated by the Shenzhen government must be submitted to

the People's Congress for approval. At the same time, local

opinion is sought and encouraged to increase the

transparency and effectiveness of the government decision-

making process. Business procedures in Shenzhen are simple

and streamlined. The Shenzhen government has also

implemented personal service responsibility to ensure that

firms' applications for various categories of government

approval are processed within a specified period of time.

Business approval procedures are currently under review and

are expected to become even more business-friendly in the

near future.

10

11

5. Key Policies Contributing to Shenzhen's Industrial

Competitiveness

One of the most important factors helping to facilitate

Shenzhen's industrial transformation has been its ability to

attract foreign investment, which undoubtedly lies behind

much of the upgrading of the city's industrial structure and

competitiveness. Output from foreign invested firms account

for more than 40% of Shenzhen's GDP. Over the last few

decades, FDI policies in the PRC, and especially in its SEZs,

have become increasingly liberal. These include: (i)

permission to set up wholly foreign-owned firms, (ii) enabling

easier access to land and infrastructure, (iii) allowing the

repatriation of profits, and (iv) favorable export and import

polices.

While FDI inflow was earlier concentrated in labor-intensive

and small-scale operations, increasingly large multinational

corporations from technology-intensive industries have begun

to enter the PRC. To upgrade its industrial structure, the

Shenzhen government has formulated a strategy to develop a

“headquarter” economy by inviting multinational companies to

move their headquarters into Shenzhen. This strategy consists

of:

(i) formulating systems to certify the headquarters of

manufacturing companies,

(ii) stipulating preferential measures to attract the

headquarters of multinational corporations, and

(iii) streamlining government procedures and enhancing

government services for companies who choose to locate

their headquarters in Shenzhen.

Third, industrial parks are an integral component of the

Shenzhen SEZ. There are about 100 industrial parks located in

12

the city, more than 90% of these located outside Shenzhen 3checkpoint , and about 70% based in villages and small towns.

Shenzhen plans to integrate the existing parks and develop 52

larger parks.

Fourth, Shenzhen encourages the formation of industrial

clusters or concentrations to benefit from economies of scale

and scope. Various industrial clusters have been formed in the

city, including clusters for the garments, bicycles, furniture,

and semi-conductor industries. All these clusters have gained

substantially from economies of scale and scope.

Fifth, in the last 3 years, in order to upgrade its industrial

competitiveness, the Shenzhen Municipal Government has

proposed policies to develop a recycling economy, with the

aim of improving the city's environment and saving resources.

On 16 March 2006, Shenzhen passed its Recycling Economy

Promotion Rules, enforcing more than 10 key procedures and

systems to assess a firm's mid and long-term performance

and planning, and to provide government procurement and

policy support for developing industries that are

environmentally-friendly and energy-efficient.

Sixth, in order to improve industrial competitiveness, the

Shenzhen Government has decided to implement a new

innovation strategy in early 2006. The aim is to structure

Shenzhen as a “National Innovative City” in the PRC. Based on

this decision, research and development investment will

account for nearly 4% of the city's total GDP by 2010. The

output value of high-tech products is expected to grow at an

annual average rate of 20% over the next few years.

3 There are 9 checkpoints in Shenzhen. They were set up at the time when Shenzhen SEZ was established. The PRC Central Government gave Shenzhen a special policy to circle the area with wire to reduce the management pressure of the border, which was connected with Hong Kong, China. People who are not permanent citizens of Shenzhen must have a certification issued by the Police Bureau to enter Shenzhen. Since the space for development within the checkpoint, which is also where the city center is located, is quite limited, most of the industrial parks are set up outside.

13

6 Conclusion

What can Pakistan learn from Shenzhen's experience of

rapidly increasing its industrial competitiveness?

Since the Industrial Revolution, economic development has

been driven primarily by (i) industrialization, and (ii)

urbanization. The development experience of Shenzhen

shows that the development trajectory of developing

economies also needs to proceed along this arc. In the late

1960s, Hong Kong, China; Singapore; the Republic of Korea;

and Taipei,China made considerable progress in

industrialization and urbanization. They serve as good

examples and models demonstrating how industrialization

and urbanization can act as catalysts for the process of

economic development.

A key factor in facilitating the industrialization and urbanization

processes, however, is the provision of open and liberal

economic policies. Industrialization and urbanization have

taken place in the PRC in parallel with its transition from a

planned to a market economy. A driving force in this

transformation has been the implementation of economic

reforms opening up the country to the world economy. In the

process, the question of how to continually promote

sustainable economic development and upgrade industrial

structures in tandem with urbanization has become a

significant issue for the whole country. From this perspective,

Shenzhen's ability to undergo rapid industrialization and

urbanization in a short span of time serves as an illuminating

example, not only for PRC, but also for other developing

countries.

The experience of Shenzhen has also demonstrated the

important difference between a SEZ and an industrial/high-

tech. The key point is that SEZs ultimately regenerate the

unification of the industrialization and urbanization processes

through comprehensive reforms. This is a critical lesson for

Pakistan as it embarks on economic reforms and

development. Too often policies of setting up isolated

industrial parks lead to the development of enclaves that fail

to propel sustainable economic growth. Shenzhen has the

most open policy in the PRC for accommodating and

attracting migrants from all over the country. It has also been

open to foreign trade and foreign capital inflow, especially

FDI. The openness to both financial and human capital has

promoted fast economic growth. This, in turn, is beneficial for

generating employment, improving people's livelihoods, and

reducing poverty. In Shenzhen, the comprehensive reforms

implemented in the SEZs by the Central Government have

been supplemented by the local government's open and

business-friendly policies, proving a powerful combination of

forces driving economic growth and development.

14

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