The consequences of investment policy changes in Poland on the Special Economic Zones example 1

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1 The consequences of investment policy changes in Poland on the Special Economic Zones example 1 1. Introduction Radosław Pastusiak and Magdalena Jasiniak Special Economic Zones (SEZs) are the tools of economic policy, supporting foreign and domestic investment to specific areas on which operates the zone. Zone has to offer some of Investment privileges, such as tax credits based on the investment value or the quantity of jobs created. In Polish conditions, where there are 14 SEZs, enterprises benefit from tax incentives, deciding to fill out the required conditions by the Treasury. However, interestingly, statistics show that just after a few months, the company exhausted the limit of income tax which were granted in the decision to tax relief. There are also many such cases that the company wants to operate in the SEZs, but do not want to use the tax relief. There are also many such cases that the company wants to operate in the SEZs, but do not want to use the tax relief. So knowingly waives the privilege. In this case, argued that the solution, which grants tax relief to all investments consistent with a certain profile, as is the case in the SEZs, the country will be a very good solution, motivating investors to invest newly technological or other. Threats in this respect is the possible concentration of investments in highly urbanized areas, where it is easy to drive business, thereby bypassing less attractive regions of the country. The main role of Special Economic Zones in Poland is to minimize the disparities between the regional development and support policy aimed at reducing of unemployment rate. Studies show, that the SEZs influence on economy growth is significant. In 2013 more than 1100 companies conducted investments within SEZs and the value of total investment expenses amounted 55 mld PLN. However, changes in investment policy in Poland are now directed into activating less attractive regions and SMEs sector. Therefore, at the end of 2014 the new legislation was implemented influencing the investment attractiveness of Polish regions. It is expected that these changes will relocate the investments to less urban areas, further from major industrial centers in Poland. But there is also a risk that value of foreign capital invested in Polish SEZs will be dramatically reduced. The main aim of this article is an attempt to identify the possible consequences of changes in Polish investment policy on the SEZs example. Authors formulate the hypothesis stating that current investments in SEZs were conducted without the argument about minimizing disparities in regional development. Radosław Pastusiak, Corporate Finance Department, University of Lodz, Poland, radoslaw.pastusiak@uni.lodz.pl Magdalena Jasiniak, Corporate Finance Department, University of Lodz, Poland, magdalena.jasiniak@uni.lodz.pl 1 Article developed within the framework of the research project of National Science Centre of Poland titled: The effectiveness of the Special Economic Zones, UMO-2013/09 / B / HS4 /

2 2. Special Economic Zones in Poland Special Economic Zones in Poland have been established under the Act on Special Economic Zones on 20 October 1994.From this moment of time the debate has been continuing over the economic consequences of their operations for businesses and for the people associated with the Special Economic Zone. A special enclave for companies was to encourage business development by getting the unemployed and improving infrastructure. Statutory privileges for enterprises operating within the zone guarantee income tax relief dependent on investment costs related to the acquisition of land, rental or purchase of its perpetual right to use, construction and modernization of fixed assets and the acquisition of intangible assets. Relief may also cover the cost of hiring new employees for two years period. Companies operating within the SEZ benefit from tax exemptions. The consequence of this is that municipalities with SEZs within their area do not receive their rightful share of taxes on businesses operating within the SEZ. These are the lost profits arising from the operation of the subsidy in the form of tax, so it would seem that the situation is unfavorable from the point of view of finances of the municipality. However, business investment within the SEZ gives rise to a network of suppliers in a given municipality, eg. subcontractors, which stimulate the development of entrepreneurship and, consequently, generate additional revenues from local taxes. Creating the infrastructure of companies around the SEZ is another incentive for stimulating the economy of the municipality. The main and most important consequence of this is the decline in unemployment. There are 14 SEZs in Poland that attracted about 1100 companies. As for the December 31, 2013, companies operating in the zones invested 55 billion zł, and created 120 thousand of new jobs in Poland. 3. Previous studies Analysis of the impact of economic enclaves on the national economy have been carried out since the 60s of the twentieth century. The studies can be divided into several trends, depending on the period analyzed. First trend is related to the study of the effectiveness of the SEZ impact on the surrounding economy. K. Hamada first tried to capture SEZ finances into one model (1974).Hamada focused on investors' financial decisions motives, he did not explain clearly the impact of SEZ on the national economy of zone founder. Then, based on the theories of foreign trade, other models were developed, whose authors were: Hamada, Young (1987), Miyagiwa (1986), Miyagiwa and Young (1987).They have been developed on the basis of the effects of zones functioning in China, other Asian countries, the Caribbean and the United States. Quite another model analyzing the effectiveness of the SEZ, taking into account the real cash flow was the Warr model (1983, 1985, 1989).He used the influence of different micro and macroeconomic factors that determine the accumulation of capital in the country, that arranged SEZ. Thus he showed that the zone had been beneficial to the national economy and served its purpose as a tool of economic policy. 2

3 Model description of special economic zones is evolutionary. As far as there were new empirical data. characterizing the operation of enterprises in the SEZ, the researchers refined the model by introducing another variable. Often, models containing additional variables, describing the functioning of SEZs in a given economy, did not apply to another. The second trend is related to the study of the relationship between SSE and FDI in the context of investors decision motives. It was noted that investments in SEZs significantly affect economic development, attracting foreign direct investment (FDI) and cause spillover effects in high-tech industries. The main trends of research in the area of SEZ impact on economic growth are represented by Willmore (1996), who analyzed the Caribbean SSE, Kung (1985) Ge (1999) and Park (1997), who performed a detailed analysis of the SEZ in China. Rolfe and others (2004) studied the operating privileges in Kenyan SEZ. Aggarwal, Hoppe and Walkenhorst (2008), Aggarwal (2005), Shah (2008) performed a comparative analysis of the operating conditions of SEZs in India, Sri Lanka and Bangladesh and Willmore (1996) Caribbean zones. Devereux (2007) examined the impact of taxation on investment locations. Litwack and Qian (1998) developed the theory of transition economies (for example China), where there was development strategy based on the SEZ. Another important current research is the impact of various factors attracting FDI and among them are the SEZ. To the group of these studies we should include research of Whalley and Xin (2006), McGrattan and Prescott (2009), Desai, Foley and Hines Jr. (2009).Other articles oriented to FDI were devoted to spillovers: Coe, Helpman and Hoffmaister (2009), Liu (2008), Hale and Long (2007) and Abraham and others (2010).Important research on China's SEZs have been included in the publications of Wei (1995), Cheng et al. (2000).Literature presented is general in nature and presents the general principles of the SEZ. Bondonio and Greenbaum (2007) indicated strong positive impact of tax incentives for U.S. economy. Berger (1993) was even searching in more narrow area, searching for tax credits impact for R&D growth. Hanson (2009) indicated a positive and statistically significant effect of the federal Empowerment Zone program. Faulks (2002) and O Kneef (2004) results also indicate a job creation effect. Positive results for labour market was also showed in Busso and Kline (2007) but there was indicated rental process increase. Kolko and Beumark (2010) however showed there is no mentioned effect in state of California, the same results received Bondonio and Engberg (2000), Fisher and Peters (2000) and Bellings (2009). Rainey and McNamara (2002) indicated that modifications to tax policy, of state and local governments will not be as effective in the future but it was before. Summarizing the review of existing studies the analysis describing Polish SEZs are also worth mentioning, especially the findings of Siudak (2011), who generally studied Polish SEZ, Pastusiak (2011), who analyzed the effectiveness of SEZ and Ambroziak (2009) dealing with legal issues. Investment policy changes The existing rules of supporting investment activities, applicable until 2014, focused on providing particular granting to the zone companies on the basis of investment expenses value 3

4 (understood as eligible costs) and the number of new workplaces created (counted as an employment costs incurred into two years period). Map presented on board below illustrate Poland, divided into regions according to the level of public aid provided. Illustration 1: The Intensity of Public Aid in Poland up to 2014 Legend: from % for medium firms +20% for small firms The intensity of public aid is an indicator that influence the amount of tax incentives provided to the investors operating within SEZs. Areas with 50% indicator are those where investors may achieve the highest benefits up to 50% of investment expenses (or 2- years employment costs) were received as tax benefits. Such diversification of investment support has divided Poland into region of Warsaw, central, east and west regions with different stages of development. The analysis of investment expenditures incurred in particular SEZs indicate that historically, the most urbanized industrial areas have attracted the highest value of investments. Data provided in table 1 indicate that since 2000 the number of investment permissions in SEZs in increasing in all zones. However, it is not equal to their intensity. The highest number of companies is located in following zones: Katowicka, Lodzka, Mielecka and Walbrzyska. These zones are located in central and northern Poland, highly urbanized regions. The economy transformation in early 90ties of XX century influenced these regions but at the same time the economy growth was at the highest degree due to the infrastructure and attractive location. 4

5 Table 1: Number of Investment Permissions in SEZs in Chosen Years SEZ Kamiennogórska Katowicka Kostrzyńsko- Słubicka Krakowska Legnicka Łódzka Mielecka Pomorska Słupska Starachowicka Suwalska Tarnobrzeska Wałbrzyska Warmińsko Mazurska Source: own elaboration Data in table 2 present the investment attractiveness of Polish regions. It should be noticed that this classification reflects investors preferences. It means that investors do not necessarily established their business where the government wish but on the areas that are attractive and provide workers and local authorities ready to support local entrepreneurship. Table 2: Ranking of Polish Regions Investment Attractiveness Group of attractiveness Voivodships (1- the highest, 5 the lowest) 1 Mazowieckie, Dolnośląskie 2 Pomorskie, Śląskie, Wielkopolskie, Małopolskie 3 Zachodniopomorskie, Łódzkie 4 Lubuskie, Podlaskie, Opolskie, Kujawsko - Pomorskie 5 Świętokrzyskie, Lubelskie, Warmińsko mazurskie, Podkarpackie Polish law regulations, related with investment support influence the investors decisions. Companies became to establish their investments in regions providing good infrastructure, labour market and effective local government. It occurs in choosing traditional investment areas - central and northern Poland. It may be concluded that 5

6 in terms of investment location nothing has changed. The main beneficiates of the whole program are most industrial regions while the main assumption of government policy was to minimize the disparities between regional development and creating new opportunities. In 2013 actions aimed at changing the law regulations began what finally occurred in new act modifying the rules of investment in SEZs, implemented in The reason for implementing such changes was also the fact that Polish companies have improved their position on international market in the form of growing value of Polish foreign direct investments. It suggests that Polish companies benefit from SEZs and the SEZs incentives became a factor creating company effectiveness instead of equalizing the opportunities to companies investing in different countries. Changes proposed by new regulations are mainly focused on public aid indicator. Illustration 2 present the new division of public aid. The darkness areas are those where the maximum level of public aid amounts 50%. In the rest of Polish regions the value of public aid is lowered. Illustration 2: Public Aid Intensity in Poland from 2014 As a consequence, companies that invest in most traditional regions in Poland will receive less benefits than companies operating in boarder regions. Investment incentives are concentrated in most needed areas and start to minimize disparities in regional development by stimulating the local entrepreneurship. 6

7 Discussion Changes in investment policy in SEZs in Poland coincided with the period of Polish investors growth and their improvement at national and international scale. The 14 years experience in SEZs operation in Poland indicates that large companies investing in SEZs are not able to influence the regional socio economic development on their own. The regional development must be supported also by SMEs that surround large companies. The role of local authorities is also really important as they create local investment policy and provide incentives to zone and non zone enterprises. This is one of the major factors differentiating regions in this area. Conducted analysis indicate that zone companies established their investments in those regions where the most convenient conditions appeared, especially appropriate labour market. It means that these investments are located in regions traditionally most urbanized central and norther Poland. Therefore, the eastern part of Poland is characterized by the lowest level of investment attractiveness. Changes in investment policy related to new division of public aid will influence these regions and have an impact on minimizing the disparities between regional development in Poland. However, the investment policy should be also strongly related with the regional strategy. East regions of Poland have a strong potential in natural and touring assets which should be exposed.unfortunately SEZs do not provide tax reliefs in this area. It is worth to mention that also investments conducted by family businesses in SME sector are increasing in Poland. Statistics show that investment activity in this area is growing what is related to capital accumulation that occurs here. Additionally, to minimize the disparities in investment availability, the mechanism of tax incentives was modified by decreasing the amount of public aid provided in most urbanized regions and maintaining the level of public aid provided on east boarder regions at the same level. It should be mentioned that very large companies still have the opportunities for individual negotiations of investment conditions, especially those offering projects worth more than 200 mln PLN (about 45 mln EUR) while SMEs, due to its status, may try to negotiate the increase of total amount of public aid. Therefore, new solution influence mostly average and large companies, investing from 5 to 20 mln PLN (about 1,2 do 4 mln EUR) relatively high but not enough to start individual negotiations. Public aid offered within the SEZs is focused in most backward regions, less urbanized what is adjusted to the main idea of public aid. As a result, the funds will be spent more rationally. However, SEZs and public aid are insufficient to boost regional development. Additional and integrated activities like: the involvement of local authorities, assigning particular functions to the regions and stimulating their development according to local strategies and geographical conditions (border regions, high proportion of protected areas within the framework f.e. Natura 2000). 7

8 Not all regions have to promote industry. Especially in rural areas, characterized by high level of low skilled and qualified workers, low level of public safety, infrastructure, the changes in social structure is necessary to achieve a satisfactory economic transformation. Conclusions SEZs in Poland are one of factors determining the growth of new investment effectiveness. It is expected that this will motivate investors to initiate their activities in Poland. However, low labour costs, privileging certain geographical areas (urbanization) have caused that investors were directed only to chosen SEZs what states in contrast with previous policy assumptions. The investment policy changes, proposed in 2013 by government, that influence also zone areas, seem to promote backward regions and investments conducted by SMEs. The Polish investment policy is turning away gently from speculative capital. SEZs are becoming a marketing tool that allows to create friendly investment environment and good overall impression of the particular region. Acknowledgement Article developed within the framework of the research project of National Science Centre of Poland titled: The effectiveness of the Special Economic Zones, UMO- 2013/09 / B / HS4 / References Abraham, F., J. Konings, and V. Slootmaekers [2010], FDI spillovers in the Chinese manufacturing sector, The Economics of Transition, vol 18 (1), Aggarwal, A., M. Hoppe, and P. Walkenhorst [2008], Special Economic Zones and Economic Diversification: Same Evidence from South Asia, in Richard Newfarmer, William Shaw and Peter Walkenhorst (eds.), Breaking into New markets: Emerging Lessons for Export Diversification, Washington DC: World Bank. Aggarwal, A. [2005], Performance of Export Processing Zones: A Comparative Analysis of India, Sri Lanka, and Banglagesh, Working Paper No 155, Indian Council for Research on International Economic Relations, New Delhi. Ambroziak A., National regional aid in special economic zones in Poland, SGH, Warsaw 2009 (polish) Cheng, L. K., and Y. K. Kwan [2000], What are the Determinants of the Location of Foreign Direct Investment? The Chinese Experience, Journal of International Economics, vol 51(2), Coe, D. T., E. Helpman, and A.W. Hoffmaister [2009], International R&D Spollovers and Institutions, European Economic Review, vol 53(7), Desai, M. A., C. F. Foley and J.R. Hines Jr. [2009], Domestic Effects of the Foreign Activities of US Multinationals, American Economic Journal: Economic Policy, vol. 1(1),

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