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I had a bad dream the other day. I dreamed that I was unfit and extremely overweight.
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Now this doesn't sound like a dream because I am actually unfit and overweight but in
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this dream I actually went to the government for help. I went to the Ministry of Health,
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found a Babu there and said to him, help me, I am unfit, I am overweight, my clothes don't
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fit me. I pant with exhaustion every time I have to speak a long sentence like this
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one, pant, pant, help me, make me fit again, oh Ministry of Health. The Babu replied, don't
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worry, we have plans to make you fit. We are setting up an SCZ for people like you. An
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SCZ? I said, what's an SCZ? He replied, an SCZ is a special exercise zone. We are setting
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up zones where people only exercise and do nothing else. Here, the nearest SCZ to you
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is a hundred kilometers from here, in a remote location where there is nothing else. Find
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it and get a workout. I want to see that bunch of yours disappear just like your hard earned
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money does thanks to our taxation policies. Do you understand? Do you understand? I told
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him I understood. I found this SCZ, the special exercise zone in the boondocks and I went
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there for a week. Then I took an annual membership and never went again. Welcome to the Scene
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and the Unseen, our weekly podcast on economics, politics and behavioral science. Please welcome
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your host, Amit Barma. Welcome to the Scene and the Unseen. In today's episode, I am
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going to be talking about SCZs or special economic zones. SCZs are special areas set
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up by governments to attract investment by way of offering business friendly regulations.
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This begs the question, why not have business friendly regulation everywhere if it's such
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a good thing, as it certainly is. SCZs have not just this conceptual flaw, but are also
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deeply flawed in the ways in which they are implemented in India. I chatted about this
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a few days ago with my friend, Kartik Shashidhar, who has a chapter on this in his excellent
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book, Between the Buyer and the Seller. Between the Buyer and the Seller is out now on Amazon
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and I highly recommend it. For now, let's talk about SCZs. Kartik, welcome to the show.
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Hi Amit. We like to be back here. So Kartik, in your book, the very first chapter is a
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fascinating chapter which juxtaposes two company shutdowns which kind of happened at the same
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time which is towards the end of 2014, a Nokia plant shutdown in St. Perambudur and it was
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placed in an SCZ there, a special economic zone. At the same time, Yahoo shut down its
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India operations and laid off tons of people in Bangalore. And the interesting thing you
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point out in the book is that while most of the people laid off by Yahoo managed to find
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other jobs and employment and weren't affected so badly, the people who were laid off by
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Nokia and St. Perambudur, on the other hand, could not find equivalent jobs and many of
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them either had to settle for much lower paying jobs or they had to migrate to towns. So why
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the difference in outcomes? Yeah, so there was a great story in Mint, by the way, a few
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days after this happened which spoke about what happened to the people who were working
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for Nokia in the St. Perambudur plant. I mean, like as an addition reading, it would be great
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to just look at what happens if you are working in a plant in a remote area where there are
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no other comparable employment opportunities and what happens if the plant needs to shut
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down. So it's a great read. I can put the link as part of the podcast. So I think the
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big difference was in terms of the location. So at the time when the Nokia plant shut down,
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there were two places in India where the mobile phones were being manufactured. There was
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this particular Yahoo plant in St. Perambudur, which is in an SCC and at the same time Micromax
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was setting up a manufacturing facility in Rudraprayal, in Uttaranchal, where again they
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had received I think some favorable tax treatment and so on. So it was like an SCC here. It
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was like an SCC more or less. And so you had two plants at two opposite ends of the country
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making a similar thing. And making mobile phones, I mean, yeah, while it's manufacturing
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and all that, it's a fairly specialized operation. So like, I mean, and both of these are like
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out of the way. I mean, St. Perambudur is still not Chennai. So it's still a bit of
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an out of the way place. So it's a bit of a hard to recruit employees when you're set
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up in such places. I mean, like, I mean, you might get great tax breaks and the monetary
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value of the tax breaks might typically be more than what you would, the premium you
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would have to pay to get employees in these places. And but what happens is that it creates
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enormous risk for the employees. Because if in case you shut down, and I mean, like,
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birth and death of businesses is a part of everyday life now. So it's like it always
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has been in case you shut down, you want your employees to have alternate employment
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opportunities. And if you are an employee looking for a job, you want to kind of hedge
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the against your company going down and you want to make sure your life doesn't get
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affected too much and so on. So if you're in an ACG where you're working with a company with
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no similar other companies there, it's a very fragile environment to work in.
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So what on the other hand, Yahoo, Yahoo, also, I think, was in some of the offices were in,
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were in what can be classified as ACG, they will export promotion parks in Bangalore.
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But the important thing is that they were all in Bangalore, which is a large city,
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which is the hub of the IT industry in Bangalore. So what you saw after Yahoo decided to start,
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close its operations in India, or that you actually had companies setting up dedicated
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portals to hire these ex Yahoo engineers, because they knew that Yahoo employed a lot of fairly
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good people. And they were now a large number of good people out in the market. So and this was
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a time when generally growth was good, the startup industry was booming. So people wanted to recruit
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good engineers. So and so and most of them managed to get jobs fairly quickly enough,
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and without really disrupting their lives, because Bangalore has a very liquid job market
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for IT professionals. So let me move to a more fundamental question now, you know,
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which is cities really, and cities are often demonized when people talk about the low quality
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of life in cities, the urban squalor, the congestion, and so on and so forth. But yet,
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the history of humanity is really a history of migration from rural areas to cities from
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less crowded areas to more crowded areas. And in fact, by the year 2045, 70% of the world will
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live in cities, it's just a continuing process, everybody wants to go to cities, very few people
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move the other way, unless they're very rich, and they buy a farmhouse and so on. But that's
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the life of the extremely privileged. So what accounts for this movement to cities? What is
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the attraction? So the attraction of cities is that like, I mean, it's manyfold. But basically,
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it is that because you are living so close to so many more people in a city, there's so much more
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you can do this so much more choice in terms of what you can do this. So many more professions
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you can pursue in a city compared to what you can pursue in a small rural area. So I think what
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what and also like if you kind of choose the right city based on your skill sets, what will also
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happen is that you will have a wide range of choice of employment in terms of where to work,
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who to work for, who to work with, and so on. So that kind of is a huge plus for cities compared
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to like smaller areas, because your life is not fragile to the fortunes of one employer anymore,
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because there's plenty of options for what you want to do. It's effectively is network effects
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like companies like to go to cities and businesses like to go to cities because there are many more
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people they can employ there. And also individuals like to go to cities because there are many more
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opportunities, not just job opportunities, but much bigger social and economic networks. And as
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all trade is a positive something you benefit the most by being in a place where you have more
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options and more people to essentially trade with. Absolutely, absolutely. So it's very simple and
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network effects like because in a city because the market is so large for anything that you want to
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do, like there are so many more services that get traded in cities compared to rural areas.
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So in another chapter in the book, I talk about the restaurant industry and talk about how like
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cities can afford to have restaurants because there are so many people and like so each restaurant can
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assume a particular market every day. But if you're in a rural area where there's a small
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number of people living there and nobody wants to eat in the same place every day unless that
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place is home, the option to have a restaurant market is so much smaller. So in that sense,
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it's like for any kind of market, be it employment, be it for things you want to enjoy or something,
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I mean, it's best done in cities where there's tremendous scale and there's far more stuff that's
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traded. Absolutely. I mean, that's why if you go to an Indian village, you'll never find an
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Italian restaurant or a sushi bar there because there simply aren't enough customers. But while
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those are very niche tastes in a city, you can cater to those niches profitably because you have
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that kind of scale. Yeah, I mean, first of all, if you go to an Indian village, finding a restaurant
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itself is like, I mean, larger kind of it's hard. I mean, it doesn't make economic sense to run a
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restaurant in a village unless you're on a highway or something. And as for sushi bars or something
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that again, like you need a really large city like Mumbai or Bangalore for it to work because
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like it's so niche that you need a really big population in your catchment area for it to be
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like commercially viable. Exactly. Like in another context you'd written in your book, there's a
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chapter where you write about feta cheese in Bangalore. And while you know, feta cheese is
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available in very few places in Bangalore and Mumbai, like nature's basket, for example,
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it will be available in some places that are cost for those who want to pay that price and
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many do I love feta cheese. And you will never ever, you know, be able to find feta cheese in
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a small town in India, for example, at least not now. And therefore cities afford the kind
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of specialization and division of labor, which makes it profitable for individuals to go there.
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And therefore, when Yahoo shut down in Bangalore, even if some of their operations might have been
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in an SCC in Bangalore, just by dint of that location, those people were able to find jobs
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because they were already in that relatively liquid market. While the market in Sri Perambudur
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was very illiquid, there was, it was an SCC, there was one company there and those guys simply
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couldn't find any other jobs. Yeah, I mean, it's easy to probably have many companies,
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but in this particular SCC, we had one mobile manufacturing company, and there was no other
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company which was similar to this company. So what happened with that? Like, I mean,
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so when you are working in a place where there's one company of a particular type,
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and you lose your job for whatever reason, right? Whether the company shut down or you fight with
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your boss or whatever happens, if you lose your job, you have nowhere to go, you need to necessarily
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relocate. So your life is necessarily kind of fragile because it's kind of tied to a particular
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employer and so on. On the other hand, if you are in a place where there is plenty of choice
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for employment, then it's good both for you and for your employer. Because let's say, for example,
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I'm like the head of engineering at a company located in some way, which has its office in some
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village, right? And I decide to leave someday. Now, my employer will have a massive task to
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find another head of engineering to replace me. But if I were the head of engineering in a place
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in Bangalore, and I left it because the market for engineers in Bangalore is liquid, it would
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hardly, the company is so much better off being there because it's very easy for them to replace
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me. So it works on both sides, both for the employer and for the employee, it works to be in
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a big city because there's more choice for both. And so like the amount of risk they have to face
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is like significantly lower. And that means a higher real estate costs completely worth it.
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I mean, it's a no brainer because the benefits are far more than the costs. Yeah, no, I mean,
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so people keep talking about how real estate in cities cost really high. I know you've done a few
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few great episodes on this podcast on real estate. I guess it's better to put links to those. But in
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a lot of cases, apart from in cases where supply has been artificially constrained for whatever
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reason, like, I mean, the high real estate cost you pay either in terms of like the rent you pay
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or in the small size of the dwellings or in terms of the quality of accommodation, it's a price that
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people are willing to pay because the value they get from being in the city is so much more.
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Yeah, I mean, it actually illustrates how much value there is because supply constraints through
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things like FSI and rent control and we've got previous episodes of the scene in the unseen on
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that prices are much higher than they should be. But regardless of that, people would prefer to be
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in cities and in smaller places. So coming to sort of the question of SEZs in particular,
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now, special economic zones or SEZs are often glorified by some people because they said that,
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look, the scene effect of that is that you create a zone which has lesser regulation than you have
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otherwise in cities. And therefore you make it attractive for businesses to set up there.
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And once they set up there, they generate employment and revenue and it kind of helps everyone.
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And of course, that's begging the question about why those regulations aren't removed everywhere
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instead of just in SEZs. But taking that for granted that they're going to remain the way
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they are. That is what many people call the scene effect of SEZs. And according to you,
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one unseen effect of having SEZs in places like Sriperem-Budur or far off areas is that you are
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not plugged into the network of a city and therefore the cost of business is actually
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much higher in SEZs. Yeah. So I mean, you were talking about generating employment, right? I
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mean, yeah, they do generate employment. If you set up a plant anywhere, you obviously need people
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so that generates employment. But when you have set it up in a place where it's very fragile
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employment, I mean, like it's very, you don't want to kind of tie your entire career and your
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life decisions to kind of the fortunes of one company, which has set up a new plant in a
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particular place, right? I mean, if the real motive is to generate employment, you need to
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kind of, you want to generate employment that's more stable, that's more like, and I mean,
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you can't force companies to not shut down and so on. But what you want is to kind of generate
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employment, which kind of gives some kind of stability where the employee is hedged against
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something happening in the job and so on. Here you generate employment, but it's very unstable
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employment because of what the Yahoo thing forces. And yes, there's no network in the city. So it's
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a very weird life that kind of, I personally haven't lived in an SCC, so I can't really comment,
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but my sense from what I read is that it's a very kind of weird life there. So you probably
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create much more value. If all these people were to kind of, rather than working in an SCC,
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if they were to work in a big town or city, there would probably be much more value being created
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because there will be so many more things that are credible there and like people are kind of,
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that's creating much more value. So would you recommend that when people set up SCC's,
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they should set it up only in big cities or would you go a step further and say that
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we need to relook entirely at the concept of SCC's to begin with?
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I think we need to relook entirely at the concept of SCC's because what happens is when you try to
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give certain kind of, by the way, the Nokia closure again, it had to do with the terms of the SCC in
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which they were located. So I think, so when Nokia sold its manufacturing business to Microsoft
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back in 2014, they didn't sell it cheaper over the plant because there was a litigation going on
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because I think there are some clauses in the SCC saying you can be here and get these benefits
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if and only if you export everything you make and it was not clear whether they were exporting all
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the phones or if they were selling some phones in India, which is completely mindless regulation.
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But because of that, that plant didn't get sold to Microsoft. It might have, if those, if it was
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not because of the, if the plant had not, let's say the plant was still in Shri Perumudur, there
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was no other mobile manufacturing unit in India. So let's say for some good reason, they would have
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chosen to put it in Shri Perumudur, which is still in a big manufacturing belt in Tamil Nadu. I think
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we have a good friend who runs a factory there. So there, like what would have happened is that
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it would have probably been sold to Microsoft and had Microsoft, what the plant, there would have
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been so many other ways in which they might have put it to good use. Maybe if they didn't want to
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make mobile phones that they would have used it to make keyboards or whatever. But because it was
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in an SCV, because it was set up with certain conditions, the whole idea of the SCV is that
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you need to follow a certain list of conditions in order to qualify for certain benefits and so on.
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It kind of restricts the kind of activity that you can do. So it's not only that there's not so much
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choice for employees and the company in terms of recruiting people, finding jobs and so on. It's
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also too restrictive in terms of what you can do. So it's almost back to the license Rajira where
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you had to take permission from the government to manufacture a certain number of units or something
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and you couldn't make one more than that. Here it's just that you can manufacture certain kinds
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of things and you can't make anything else. So it's a very very counterproductive regulation but
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because it produces certain incentives, a lot of companies end up taking those incentives for
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short-term benefits. So out of these two options which I'm just thinking at the top of my head,
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out of these two options which make more sense to you, one is that you keep SCVs but you redesign
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the incentives in such a way that you don't have all these crazy cumbersome regulations and you
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keep them near cities or whatever. And the second is that you do away with SCVs altogether because
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of the logic is that less regulation or better conditions will attract more businesses. Since
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that is a positive sum game, just spread it out everywhere, offer it to everyone. I mean everyone
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benefits from that right? So which seems more... It's very clear to me that the second one is a
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better option because first one involves too much design. It involves too much intelligence on part
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of the designer regulator who comes up with these rules and so on. So if you kind of and there's a
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very high chance of it kind of going wrong. So in that sense, it's okay if we are slow to move on
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labor reforms or whatever. It's okay because I think in the long run, I think what SCVs create
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is that they give you short-term benefits in terms of tax benefits or freedom for a few years from
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certain labor regulations and so on. And companies are very happy to bite on those short-term
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benefits and they end up locating there. But it creates long-term problems. It doesn't result in
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kind of sustainable long-term growth. It doesn't result in sustainable long-term improvement in
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regulation and all. It's a kind of a bandaid that you kind of put on a deep cut. So you're better
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off kind of not having SCVs at all. And yeah, in the short run, less jobs might end up being created,
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but I think it's a more sustainable solution. And you'll also see that the mainstream regulation
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is easier to change when everybody's part of it and so on. Yeah. And this seems to go back,
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I think, to the central question of trying to centrally plan an economy. An SCV seems to me
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to be a sort of a jugard done by a central planner, while that should really not be the case,
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while cities arise organically from supply and demand and network effects and so on.
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So the ideal role for governments, since they can never possibly have all the information
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available to them to run a market as Hayek explicated so brilliantly 80 years ago,
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is that just to take a hands-off approach and let things develop organically.
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Kartik, thanks so much for coming on the show. I learned a lot from reading your book and
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I've learned a lot from this episode as well. Thanks so much. Bye.
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If you enjoyed listening to the Scene in the Unseen, check out another great show by IVM Podcast,
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Made in India, hosted by my friend May Thomas, where every week she profiles
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up-and-coming independent Indian bands.
