Part 2- Special Economic Zones: Making Them More Effective

Government has launched the Make In India campaign to boost the domestic production. The success of this initiative depends largely on the basic infrastructure available to industries. The SEZs can play a pivotal role in the success of this program.

The Indian Export Problem

India’s exports have been declining for 13 months. To reverse the trend, the commerce ministry wants to exempt exporters in special economic zones (SEZs) from all corporate taxes, including the minimum alternative tax (MAT). This is a bad idea. It goes counter to finance minister Arun Jaitley’s welcome proposal to abolish most tax exemptions, and have a uniform low rate that does not arbitrarily favour this unit or that region.

Favouring SEZs leads to not just a big loss of tax revenue but to cronyism (several SEZ land allocations became scams), and waste (units will shift to SEZs despite big expense and loss of productivity, just to get the tax break). Many companies that would be exporting from traditional bases anyway will shift to SEZs for the tax break. SEZ exports may look big, but may not represent additional exports or policy success. They may simply represent policy failure through export diversion and revenue loss.

India has an export problem right now but not a balance of payments problem. So there’s no need for panic or emergency measures. The current account deficit is well under control at barely 1% of GDP, since imports have fallen along with exports. China’s slowdown has led to a global export slowdown. Almost all Asian countries are suffering from falling exports, and many have suffered steeper declines than India.

What is urgently needed

To be competitive, India needs both competitive facilities (in and outside SEZs) plus competitive tax rates with very few exemptions. India has a corporate tax rate of 30%, and with cess and surcharge this comes to 34.5%, one of the highest in Asia. Finance minister Jaitley rightly seeks to cut this to a competitive 25 %, while removing today’s myriad exemptions so that he does not lose tax revenue. This is a laudable, far-sighted reform. It should not have holes punched in it by demands for tax breaks from SEZs or other interest groups.

In dismal global conditions, tax breaks are irrelevant for export buoyancy. We must instead raise our competitiveness through better logistics, skills and procedures. Only then will exports boom sustainably. We cannot have lousy facilities and yet become world-class exporters through tax breaks. Ideally, the whole of India should have world-class facilities. Since resources are limited, a start can be made in SEZs.

Part 1- Special Economic Zones: Making Them More Effective

Special Economic Zones or SEZs are some geographical regions in which the economic laws are more lax when compared to a nation's domestic economic laws. These liberal laws are put in place to boost the business, increase FDI, increase domestic production and to have more job creation.

Historical perspective and the Chinese success story

Between 1965 and 2005, India built eight tiny export processing zones( a type of SEZ), with very limited success. By contrast, China succeeded in creating massive SEZs. These behemoths have world class power, water, ports and airports, and have become world-class manufacturing clusters. These SEZ were instrumental in making China a global manufacturing hub.

Indian Story

In 2006 we adopted a new SEZ policy. The main provisions of this policy were-

1. Tax exemption for units in SEZs for five years( not even MAT was to be collected),
2. The units were to get a 50% tax break for next five years,
3.  A further five year tax break for reinvested profits, and
4. SEZ developers would also get a tax holiday for 10 years.

Results of this policy change

Instead of creating massive SEZs, this policy encouraged hundreds of small SEZs in every state. These amounted to tax shelters and a grab for land rather than world-class enclaves. No less than 564 proposals for SEZs were approved, but of these only 204 are actually functioning. Most operating SEZs are small IT establishments that are little more than tax havens.

The 2006 Act provided that the minimum size for information technology, jewellery and biotech parks should be just 10 hectares, smaller than even some schools. Size limits were kept especially low for hilly areas, where flat land is scarce. This was a classic case of making SEZs an end in themselves rather than a means to improve competitiveness. China does not create tiny SEZs in the Gobi desert or Tibetan mountains: it creates large ones in areas with the best logistics, infrastructure, financial and transport facilities.

Exports from Indian SEZs rose from $5 billion in 2005-06 to $81 billion in 2013-14. This looks very impressive. But a lot of it is simply trade diversion. Many top IT and jewellery companies shifted their operations to SEZs for the tax break. Since units outside the SEZs continued exporting at a good rate, it is unclear whether the SEZs achieved additional exports or just diverted exports.

Because of such factors, MAT and the dividend distribution tax was imposed on SEZs in 2011-12. Industries protested that this discouraged additional investment. True, but would this fresh investment have been for export diversion or export addition? The operating profit margins of software companies often exceed 20%, so they hardly need tax breaks. Old export units in areas from textiles to engineering, many having very slim operating margins, get no tax breaks. Why should they be discriminated against?

Compulsory Licenseing And Intellectual Property Rights (IPR) - Indian Perspective

After the United States, European Union (EU) has recently taken the baton of pressurizing India on its adoption of Compulsory Licensing (CL). This was reported by The Hindu quoting a senior EU official as saying,"the extension and wise use of CL in industrial sectors can act as a deterrent for investments, from abroad and within India." These comments were made when India is trying to frame and adopt a new National Intellectual Property Rights (IPR) policy. Similarly, in the past US has also called Indian IPR as a “contagion” of weakening intellectual property.

Before dwelling into the Indian perspective, we need to understand, what is actually meant by IPR?

Intellectual property rights are given to individual or organization that have created something novel and of commercial value and these rights exclude others to manufacture, sell or use products based on their novel idea. World Trade Organisation is the governing body in case of international violations of IPR.

Compulsory Licensing by government allows entities to use the patented technology without obtaining the permission of the patent's owner. According to WTO TRIPS (IPR) agreement CL is allowed under the following conditions- 

1. National Emergencies
2. Other circumstances of extreme urgency
3. Anti competitive practices are fulfilled.

Any Government can use these safeguard measures in special circumstances for the benefit of its people, for example in issues related to health care.India issued compulsory license to an Indian company Natco pharma in 2012 to manufacture cancer drug nexavar and sell it at a very low price. The use of compulsory license by India was done to make a drug accessible to its population which could save many lives. The step taken by government considering the importance of public health was fully compatible with TRIPs and well within the boundaries of its patent laws.The big pharmaceutical companies in USA were not happy with India's decision. The government of US in retaliation ranked India lowest in US chamber of commerce's IP survey 2014.The USA even listed India as "priority country" which is the worst classification given to countries. 

The inaccessibility of important medicines is an immediate health problem. The one compulsory licence issued on Bayer’s product — Nexavar, a medicine used to treat late stage cancers of the kidney and liver — illustrates this.Representatives from Bayer and PhRMA have noted that Bayer was making the drug available at a lower “access price” in India.However, if one converts the full price and access price to US dollars (based on a January 2013 exchange rate) and compares them to the average annual income-by-quintile as reported by the World Bank, the data shows that both prices exceed annual income of even the top 20 per cent of Indian earners.It drives home the point that the current trade dispute between the US and India is about more than bland-sounding global norms regarding patents.

The recent comment by an EU official that CL in manufacturing may slow investment and damage their exports may appear at first glance to be legitimate and fairly convincing argument. However, upon further examination of the argument and juxtaposing it with  the data from previous years, a flaws become evident.

Overall pharmaceutical exports from US increased from $39 million to $225 million during the period 2000-2012 — an increase of 470 per cent.Furthermore, US pharmaceutical exports to India are growing at a faster rate than US pharmaceutical exports to the world as a whole. Moreover, many pharma companies are thriving in India: Abbott, GSK, Gilead, to name just a few. A similar case could be made for EU also.

India is a representative of many developing countries who in the past have used these flexibilities in patent laws for welfare of its people. All eyes are set on WTO, it will decide whether WTO is a guarantor of public welfare or it is a threat for millions of underprivileged people on this planet. And whether or not people in India (and elsewhere) will be able to access important new medicines and other technologies, especially green technologies, as they enter the market.