By Emilio Arteaga*
In September, Mexican President Enrique Peña Nieto announced an initiative to create Special Economic Zones that is yet to be approved by the Mexican Congress Senate. The proposed initiative will set forth the legal framework with the intention to mirror successful policies adopted around the globe, such as China’s Special Economic Zones. If the Law is adopted, the President claims that he will create three Special Economic Zones that will be located at the South-Pacific coast in order to take advantage of Mexico’s geographic competitive advantage.
The alleged purpose of this law is to close the alarming economic gap between the North and South of Mexico by creating an enabling business environment and integrating the South with global value chains. While the North and Center of Mexico have attracted considerable amounts of Foreign Direct Investment, developed important industrial hubs, and GDP per capita has increased, the South’s economic development has performed poorly and faces high poverty levels. In order to attract private investment in the south of Mexico, the President announced billions of pesos in infrastructure as well as tax and finance incentives as part of this new economic policy.
Given that subsidies are subject to the disciplines established within the legal framework of the World Trade Organization (WTO), one might question whether Mexico’s initiative is WTO compliant. Therefore, this entry explores whether the cited initiative conflicts with WTO Law. By doing so, it will first provide a brief explanation about Special Economic Zones, China’s Special Economic Zones, and the initiative proposed by the Mexican president.
II. Special Economic Zone
Special Economic Zones (SEZ) are broadly defined as a
“demarcated geographic areas contained within a country’s national boundaries where the rules of business are different from those that prevail in the national territory. These differential rules principally deal with investment conditions, international trade and customs, taxation, and the regulatory environment; whereby the zone is given a business environment that is intended to be more liberal from a policy perspective and more effective from an administrative perspective than that of the national territory.”
In that sense, enterprises that operate or have activities within the SEZ may benefit from duty, tax and regulatory facilitation measures, including exemptions, because they are located within a designated area. By placing the SEZ in strategic locations and providing incentives, it is believed that this types of policies attract investment and promote the economic development within a region. When implemented adequately, this policy may bring, for example, the following benefits: i) regional competitiveness; ii) industrial hubs and investment; iii) promotes infrastructure developments and exports, as well as production diversification.
SEZs are not a new policy. The first SEZ was established in Ireland in 1959, and over the years they are increasingly popular in several countries and regions, particularly Asia. China’s SEZs, for example Shenzhen, are highlighted as successful SEZ models. Mexico has years of experience in this type of policies, though it differs to some extent to the Chinese models. Mexico, for instance, created a special customs and tax regime applicable to economic operators that are located near the northern and southern border.
I. China’s Special Economic Zones
Since its opening up to international trade in 1978, China developed industrial policies to promote its economic development, such as implementing SEZ. By locating SEZ in coast cities (or towns) and granting tax benefits to companies that invested within the said zone, China’s main purpose was, among other goals, to attract foreign investment, promote exports, and transfer foreign technology to domestic firms. SEZ in China have served as a “laboratory” where new trade and investment policy are tested, and if the tested policies are successful they are later introduced to China mainland.
Before China accession to the WTO, foreign-invested enterprises (FIEs) could benefit from preferential income tax policies provided that they were located within the SEZ. For example, the statutory income tax rates were 33% for domestic enterprises, while 15% or 24% for most FIEs located in SEZs and other zones. In 2007, once China had already acceded to the WTO, it adopted the Enterprise Income Tax Law that introduced a unified tax rate of 25%. Consequently, the incentives for foreign-invested enterprises were largely eliminated, but others, such as high-tech activities, remained.
Why did China modified its general tax regime? When China acceded to the WTO it was subject to the disciplines of the Subsidies and Countervailing Measure (SCM) Agreement, an agreement that constitutes an integral part of the WTO Agreement. The SCM agreement introduces certain disciplines that will be discussed below.
IV. Overview of Mexico’s initiative of Special Economic Zones
As mentioned above, the purpose of Mexico’s initiative of creating SEZ is to promote economic development in certain regions that are considered ‘under-developed’ by increasing and attracting investments, productivity, competition, and jobs.
According to the proposed law, enterprises in an SEZ may engage in activities relating to the manufacture, processing, transformation, and storage of goods, as well as the provision of services related to those activities. For a city or region to be granted the status of an SEZ the following conditions must be fulfilled:
- it must be located in a State that has high poverty levels;
- it must be located in a strategic location with access to highways, airports, train, ports, or inter-oceanic corridors, and with the potential to connect to national and international markets;
- Other two conditions.
Accordingly, a special customs regime will be applicable to goods that are introduced in an SEZ, which will aim to facilitate trade and activities within the zones.
The enterprises that invest within the Special Economic Zones may receive tax, customs, and financial benefits, and they will also enjoy “flexible” regulations and competitive infrastructure. Some of incentives will be of a temporary nature and will gradually decrease, and they should aim at creating permanent jobs and productive investments that promote the economic development that surround the SEZ.
Parallel policies have to be implemented in the field of education, public security, technology & communication, finance, support services, and the integration of domestic goods in productive chains.
In theory, the activities conducted within the SEZ must be guided by the following principles: sustainability and the full respect of human rights. In that sense, the Ministry of Economy will carry out a study that analyzes its environmental and social impacts before declaring a certain region an SEZ. In addition, the Federal Government must implement several mechanisms to consult with indigenous and vulnerable communities in order to respect and protect their rights, while the operator of an SEZ must adopt actions that safeguard and protect such groups.
For each SEZ a mixed commission will be created, where authorities, private sector, civil society, among others stakeholders, will be involved and have an advisory function in several matters, including ‘development’ policies and the performance of the SEZ.
Finally, an enterprise must be granted a permit to invest within the SEZ pursuant to some guidelines that will be published by the Ministry of Treasury.
V. Does Mexico’s Initiative conflict with WTO Law (SCM)?
Although it is still not clear the design and structure of the tax and financial incentives that enterprises within a Mexican SEZ will most likely enjoy, such incentives will probably fall under the definition of “subsidy” and be considered specific. Thus, they would be subject to the disciplines of the SCM agreement.
Subsidies are defined broadly in article 1 of the SCM. In essence, subsidies are a financial contribution by a government (or any public body) within its territory or any form of income or price support, and when such governmental assistance confers a “benefit.” In that sense, a subsidy is necessarily an action that is attributed to the government, which may take several forms, and where the recipient is in a better position in the relevant marketplace if it were not for the subsidy.
Subsidies are not per se prohibited, though some of them are and others may be subject to remedies. Prohibited subsidies are those whose access is conditioned on an export performance or use of domestic goods. Such conditions may either be expressed in a law or regulation (i.e. the law provides that the recipient must export, for example, a certain amount of value/volume) or be discerned by the government’s practice (i.e. de facto conditioned) when it grants the subsidy to certain recipients based on their actual or anticipated exportation or export earnings.
Though not contingent upon exports or the use of domestic goods, subsidies that are “specific”, meaning that they are granted to a certain enterprise, group of enterprises or industries, are “actionable” under certain conditions and if they produce adverse effects to the interests of other WTO Members. Actionable subsidies can be challenged by WTO Members either at the WTO, through a process laid down in Article 7 SCM, or impose countervailing measures provided that a WTO member follows the procedural and substantive requirements established in part IV of the SCM.
Turning to the SEZ initiative, Mexico would be providing a financial contribution to enterprises located within the SEZ because they would be receiving, albeit temporally, lower income tax rates, lower interests rates or any other kind of incentive or support. This is so because, for instance, Mexico would renounce government revenue that would be otherwise collected, as enterprises within an SEZ would pay less taxes than those that are located outside of the SEZ.
Whether the above mentioned financial contributions confer a benefit to a recipient, and thus fall under the definition of subsidy of the SCM, is a question that not always has a straight forward answer (it is difficult and controversial to set the appropriate benchmark /comparison to analyze the extent of the benefit). However, one may argue that enterprises within an SEZ would benefit of more favorable financial contributions than those available in the market, considering that the relevant market encompasses like-enterprises/producers that carry out economic activities outside the SEZ and that are subject to higher tax rates or interest.
As for the specificity, this hypothetical subsidy would be “specific” in accordance with article 2.2 SCM, because it is granted to a group of enterprises that are within a designated geographical region. Given that these hypothetical subsidy is specific, it falls under the category of actionable subsidies.
The design and structure of Mexico’s subsidies are still in an early stage, nevertheless, one can provisionally conclude that Mexico’s initiative is not, in its face, contrary to WTO Law. Future rules will be relevant to determine whether Mexico’s subsidies are de jure WTO compliant or not. This is so because the initiative does not provide that access to tax and financial incentives are conditioned on export performance or the use domestic goods. These possible subsidies, however, may fall under the category of prohibited subsidies if Mexican officials only admit certain enterprises to invest within the SEZ based on their actual or anticipated exportation or export earnings.
If the aforementioned subsidies do not fall under the category of “prohibited” subsidy, they would nevertheless fall under the category of “actionable” subsidy because they are specific for the reasons mentioned above. Hence, WTO Members may challenge Mexico’s subsidies at the WTO or impose countervailing measures pursuant the SCM agreement.
Mexico’s initiative has a legitimate objective as it seeks to provide assistance to disadvantaged regions for their (economic) development. Therefore, one may question why would WTO Members restrict the use of this type of legitimate subsidies? Article 8.2 SCM, in fact, recognizes that this type of subsidies are not ‘actionable’, however, the life-span for using these and other subsidies, such as environmental, expired more than 10 years ago as they were not renewed. WTO members should bring article 8.2 SCM back to life article to ensure the predictability and security for economic operators that benefit from subsidies that, for instance, promote the regional economic development of disadvantaged regions or encourage the use of green energies. In light of the current global challenges, such as climate change and inequality between and among countries, it is clear that something has to be done in the field of subsidies to allow governments to correct (or even create) markets through the use of subsidies to tackle poverty and environmental issues.
SEZ by themselves are not the solution for the alarming economic state of the south of Mexico. The fact that China’s and other Asian SEZ were a success does not automatically mean that Mexico’s will also be a success. Mexico does not have so much of a regulatory space as China initially had with its SEZ, given that Mexico has a large treaty network (i.e. WTO, Free Trade Agreements, and Bilateral Investment Treaties). The success of China’s SEZ may be attributed to a progressive trade and investment liberalization, strategic geographic locations, income tax incentives that were contingent on exports and the use of domestic products, and transfer of technology to domestic firms, among other reasons. In contrast, Mexico has liberalized virtually all of its trade and investment policies, and cannot require investors, either domestic or foreign, to transfer technology to domestic firms or establish performance requirements.
China, like Mexico, may no longer adopt ‘subsidies’ that are contingent on exports or the use of domestic products because it is a WTO member. After acceding to the WTO, China had to modify its tax regulations removing most of its income tax incentives within its SEZ in order to ‘achieve’ compliance with its WTO obligations. Notwithstanding the foregoing, China’s SEZ remain attractive to foreign investment due to their geographic location, the amount of industries that are located within the SEZ, and trade, customs, and investment facilitation measures within those zones.
As noted, Mexico cannot adopt subsidies that promote exports or the use of domestic goods, nor can it require foreign investors to transfer technology to domestic firms. In that sense, Mexico will not be able to replicate features that made China’s SEZs attractive in the past and lead to their regional development. Mexico will thus have to allocate large sums of its budget in new infrastructure to make its SEZ attractive to domestic and foreign investment. Furthermore, and given that Mexico’s subsidies are subject to the disciplines of the SCM agreement, one must highlight that if this policy is successful and starts to affect the interests of other WTO Members it risks of being challenged at the WTO or products produced therein may be subject to countervailing measures due to the specificity of the subsidy.
SEZ may prove to be an excellent policy to integrate the South of Mexico with global value chains, and thus creating jobs and lifting the standards of living of many Mexicans in a region that lacks of industrial hubs, infrastructure (communication & energy), security, and human talent. However, it remains to be seen whether Mexican authorities persuade investors to locate their investments in Mexico’s future SEZ and simultaneously avoid disputes at the WTO, if this policy and subsidy turn into a success.
(* The author is a Mexican licensed lawyer. He recently completed his LL.M. in International Trade and Investment Law from Maastricht University. His areas of interests are International Economic Law, particularly International Trade Law. He can be contacted at firstname.lastname@example.org)