Free Zones and Special Economic Zones. Understanding the business model and the main impacts

Industrial Logistics Parks (ILPs): Definition and Major Types

ILPs are “geographically demarcated areas, developed and subdivided into plots according to a comprehensive plan with provision for roads, transport and public utilities, with or without built-up (advance) factories”.  ILPs are employed to boost economic growth through the supply of real estate products under specific management and incentives schemes that make them differential from other areas in a country. Free Zones (FZs) and Special Economic Zones (SEZs) are two kinds of ILPs. Another two types of ILPs include: Industrial Estates (IE) and Free Trade Zones (FTZs).

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Depending on the stage of economic development, each type of ILP has a specific set of characteristics:

  • Industrial Estates (IEs): IEs are areas designated to attract industrial and logistical activities in a specific territory physically separated from populated areas, boosting the creation of economic activity. Potential incentives in granting of permits, discounts in pricing of leased products and/or utilities.
  • Free Trade Zones (FTZs): FTZs are fenced and customs duty-free (bonded) areas or warehouses, offering logistics facilities aimed at trade facilitation and hosting limited value-added activities. Tenants may enjoy a different regulation from mainland, with incentives typically aimed at boosting trade.
  • Free Zones (FZs): FZs are areas aimed at boosting the activity with foreign markets by providing differential regulation for overseas companies, enabling them to operate with economic incentives and free trade conditions (in bonded regime).
  • Special Economic Zones (SEZ): SEZs are areas of integral development, including any type of economic activity and land uses (i.e. residential). SEZs are often granted with a degree of freedom in regulation, on top of incentives found in FZs, but they do not necessarily have bonded status in their area.

Although those 4 types of ILPs look very different, they still share many common features, which include:

  • Geographically delineated area
  • Single management or administration
  • Subdivided into plots and pre-built facilities (Pre-built warehouses, built to suit warehouses, cold warehouses, etc.) to be leased or sold
  • Infrastructure provided (roads, utilities, security, etc.)
  • Services provided for their tenants and their economic activities (Offices, customs, services to people, services to cargo, services to vehicles, etc.)
  • Benefits or incentives to investors in the zone
  • Tax or customs exemptions (in some cases)
  • High impact in regional economy and FDI attraction
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Number of Industrial Logistics Parks (ILPs) worldwide, estimated 2018

ILPs are playing an essential role in boosting industrialization and growth across the globe. Today, there are around 2,200 Industrial Logistics Parks in the world with an important socio-economic impact:

  • More than 1,100 ILPs (50%) are located in Asia (with the largest portion being in China).
  • Around 70 million jobs associated to ILPs have been created around the world (40 million are in Asia).
  • Almost half of these free zones are privately owned.

The different applications of FZs and SEZs

As opposed to Industrial Estates (IE) and Free Trade Zones (FTZ), which both operate on a local level, Free Zones (FZs) and Special Economic Zones (SEZs) act as global platforms interacting with other international entities.

Usually, FZs and SEZs are located in the surroundings of transport infrastructure (ports, airports, railway). For example, JAFZA is the main Free Zone in the Middle East and falls under DP World’s direct management. Both Jebel Ali Port and JAFZA share common commercial teams and strategies, working in synergy to attract cargo and tenants that has made this node the most successful logistics hub in the region.

FZs and SEZs may be planned around different core activities, usually set according to the context and location in which they are developed:

  • Trading (re-export): Import, export, re-export, transit, handling and application of low value-added services (e.g. labelling) for re-distribution, in bonded conditions
  • Logistics: Provision of transport, storage and cargo handling services to other parties, whether for local or international
  • Light industry: Production of goods from semi-finished parts, in which the value of new goods does not exceed a certain amount
  • Heavy/medium industry: Production of goods from raw materials or basic goods, typically through energy intensive processes
  • Services: Provision of all types activities of not involving the physical trade or process of goods, for B2B or B2C (e.g. consulting, repair and maintenance, etc.)
  • Leisure: Provision of recreational areas, from parks, green areas, cinemas, restaurants, commercial centres, etc.
  • Residential: Development housing for any kind of standards (from basic to high end), generating township and community
  • Tourism/Hospitality: Provision of hotels, resorts and other facilities aimed at attracting tourism and its related activities
  • Education: Provision of education at all levels, from schools to university campuses, research parks, knowledge centres, art and museums, etc.
  • Others: O&G support bases, financial services, IT and high-tech, media, agriculture, mining, quarrying, etc.

FZs and SEZs impact on sea ports

FZs/SEZs have been a main growth driver for sea ports by creating a retro-feeding effect. A good example of this is the success story of Jebel Ali and JAFZA:

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Retro-feeding effect with ports

1. Establishment of Jebel Ali Port

Jebel Ali port was established in 1976 and was focused on covering the UAE market. At first, it operated without a FZ/SEZ as demand only came from the mainland population and local industries. The port operated mainly for O/D (Origin/Destination) cargo with the mainland as its primary consumer/sourcing market.

2. Setup of JAFZA

Jebel Ali Free Zone (JAFZA) was established in 1985, providing incentives for the trading, handling and re-export of goods through Jebel Ali port towards the Middle East and South Asia. This is where Jebel Ali Port facilities have started improving drastically by making use of technology and customs processes.

3. Consolidation of Dubai as a hub

JAFZA has consolidated its position as one of the major trading hubs in the Middle East by boosting its processing capacity, turning it into a world class port. Jebel Ali has become a transhipment hub for the region, partly supported by the connectivity generated by JAFZA. Both JAFZA and Jebel Ali created more than 450,000 direct and indirect jobs in Dubai, which has multiplied in size as an O/D market for the port.

FZs and SEZs impact on global supply chain

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Role of FZs and SEZs in global supply chains. Data source: ALG analysis

The global supply chain is the combination of infrastructure, means of transportation and information enabling the movement of goods between sourcing (supply) and consumer (demand) markets across the globe. Two main operating models are identified: Point-to-Point and Hub:

  • In point-to-point models, sourcing and consumer markets are linked without involving major breaks in their supply chains. Stocks tend to be located either at origin or at destination and delivery planning is usually driven by the spot demand in each consumer market (pull supply chain). Economies of scale are mainly built on having fewer but larger deliveries, increasing the risk of stockout or overstock at destination.
  • In hub models, an intermediate logistics point (hub) is strategically located between Sourcing and Consumer markets. Stocks are supplied regularly in large deliveries to the hub (push supply chain model), where they are stored, handled and/or processed until there they are distributed to the different consumer markets upon demand (pull supply chain). This model fosters economies of scale while reducing supply chain uncertainties of point-to-point models. In contrast, duplication in import fees (in hub and consumer market) as well as overseas tax and business regulation may increase costs for traders significantly, sometimes not compensating the hub effect savings.

 FZs and SEZs are real estate assets with a strong focus on logistics, which can provide customs, tax and business incentives that compensate the above regulation-related costs found in hub models. This makes them highly attractive to act as hub between third countries (re-export), especially when coupled with strong connectivity and qualified labour.

FZs and SEZs impact on economic growth

The emergence of FZs and SEZs has made a considerable impact on employment, trade, tax incentives, international talent acquisition and real estate all across many different areas including the public sector, geopolitics, research & development, social & environmental policy making and logistics sector.

Looking at employment, both ILPs contributed to the creation of a large number of jobs both directly and indirectly to cater for the operational needs of new FZs and SEZs. On a regional level, creating jobs to support the growth of the population in the region triggered by these infrastructures, as well as boosting employment in the logistics sector.

From a real estate point of view, buildings and other assets located nearby have been revalued, residential and tourist infrastructures, in particular.

In terms of trading, FZs and SEZs have helped increase volumes and thus support economies of scale. Moreover, starting a trade business requires lower initial investment thanks to reduced costs of trade and supplies inside FZs and SEZs.

These are just a few of the many examples of how FZs and SEZs contribute significantly to the implementation of government policies as well as the economic growth. This is one of the main reasons why governments have historically supported the development of them either through direct investment or through the participation in the shareholding of the operating companies running them.

Main conclusions

FZs and SEZs are global trading platforms which can be implemented for different objectives. They have proved to be some of the most significant investments ever made on a national and international level:

  • Firstly, they have disrupted the maritime market, changing the way sea ports operate.
  • Secondly, they have contributed to the growth of numerous economies around the world by instantly accelerating many of their components.
  • Thirdly, they have drastically improved the global supply chain network by making the hub model efficient.

These are the main reasons that have pushed (and will keep on pushing) governments and private entities to invest heavily in FZs and SEZs.

About the authors
Genís García-Alzórriz holds a MSc. in Civil in Engineering and a Manager at ALG.
Yassine Derkaoui holds a MSc. in Management and is a Manager at ALG.
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