Peering through the floor-to-ceiling windows on the 68th floor of Kaohsiung's landmark 85-story Tuntex Sky Tower, one sees the full expanse of the city's harbor. At one end is the Kaohsiung Exhibition and Convention Center, which will open in October. At the other end, construction is underway to expand the port, including the second phase of the Intercontinental Container Terminal and the development of a "Nansing," or "South Star," economic zone.

Kaohsiung Mayor Chen Chu, who has worked closely with Taiwan International Ports Corporation in recent years to revamp the city's port and waterfront, can only sigh in frustration when talk turns to the "free demonstration economic zones," which will soon open around Taiwan.

"Ever since President Ma began talking about free economic demonstration zones, everybody has felt Kaohsiung was best positioned, with the biggest cargo traffic of any port and plenty of land. But now it's become 'six ports, one airport,' and resources have been dispersed," Chen says.

"Then added to that were the 'front shop, back factory' model and a virtual financial zone. To be honest, I don't know what a free economic demonstration zone is anymore."

Taiwan's Unique Economic Zone Model

Having traveled around Asia, a team of CommonWealth Magazine reporters was shocked to discover when it returned to Taiwan that its "free economic demonstration zones" were sharply at odds with special economic zones set up elsewhere in Asia that actually concentrate their resources and have clearly defined purposes.

The demonstration zone model formally promoted by Taiwan's government has at least three major "unusual" characteristics.

First, resources will not be concentrated on a single project but instead spread over eight zones – six ports, one airport and an agricultural zone.

Second, how the zones will be positioned remains unclear. There is no clear direction yet on which industries each zone (aside from the agricultural zone) will be targeting.

Third, "virtual" zones have become part of the picture, with some of the potentially targeted sectors, such as the financial and medical sectors, having nothing to do with the demonstration zones' physical locations. That has hindered communication on the policy and sowed confusion among local government and business leaders.

"Right now, some people understand (the demonstration zones) and some don't. But within the next six months, when they see tangible results, everybody will get it," says a confident Kuan Chung-ming, the head of the Council for Economic Planning and Development (CEPD) and the main driving force behind the initiative.

"Taiwan will become a different place," Kuan pledges, unperturbed by the doubts in the minds of local government leaders and the private sector.

"Having the financial sector (be included in the demonstration zones) is just the beginning," he boasts. "By the end of the year, we will allow a number of other sectors to be part of virtual demonstration zones."

To explain this stark contrast between the central government's unabashed confidence and the skepticism of others, one must begin by figuring out what exactly a "free economic demonstration zone" is.

"If we first separate the real and virtual zones for discussion, it will be a lot clearer," says Vice Premier Mao Chi-kuo in an interview with CommonWealth Magazine.

The "six port, one airport, one agricultural zone" plan, Mao says, was actually founded on the initiative launched in 2003 to create free trade zones in five ports (Keelung, Taipei, Taichung, Kaohsiung and Suao) and one airport (Taiwan Taoyuan International Airport). It then adds Anping Port in Tainan and the Pingtung Agricultural Biotechnology Park to the mix.

The extensive relaxation of customs regulations under the plan will enable more domestic manufacturers and agricultural product processors that export goods and qualify as "free trade area vendors" to import raw materials duty-free and get other tax benefits. They will not have to be physically located in the demonstration zones, thus the term "front shop, back factory."

The services Tonglit Logistics Co. in Taipei Port provides for Toyota show how the system will work. Using its facility in a free trade port, Tonglit gets import-duty, value-added tax and excise tax benefits. When imported components arrive at the port, it uses an electronic tracking system to declare them to Customs and delivers them to areas outside the zone once they are cleared. It then has Kuozui Motors Ltd. and 21 other suppliers use the components to assemble Toyota's Altis for export to the Middle East. Tonglit is the "front shop" and Toyota and its 22 suppliers represent the "back factory."

But service businesses in areas unrelated to logistics or trade, such as medical or financial enterprises, will have nothing to do with these free trade zones, even if they will have access to the benefits. Simply put, the government is using the demonstration zones to ease regulations in a bid to encourage innovation and the launch of new businesses.

Deregulation Not Linked to Special Zones

The government's plan to deregulate the financial sector dates back to when Kong Jaw-sheng headed the Financial Supervisory Commission (from 2004 to 2006) and advocated a policy of giving financial institutions greater regulatory leeway according to their fundamentals.

Under the commission's current draft plan, banks that meet specific criteria (such as having a highly ranked capital adequacy ratio) will be allowed to sell more sophisticated or higher-risk foreign exchange derivatives to customers with specialized knowledge, such as institutional investors and wealth management clients.

"Fund flows are liquid. They cannot be restricted to within a specially designated area. So we are using the virtual zone concept to gradually ease financial supervision," Kuan explains.

Deregulation, however, can be done on its own. So why has it been bundled with the demonstration zone initiative? The answer: public relations. Including the financial sector and other sectors unrelated to the zones in the plan is designed to strengthen the government's image as "liberalizing in a controlled way" and earn society's trust, Mao says candidly.

Kuan, an economist by trade and a stout believer in free market economics, adds, "This is being done to save time. It's waging battle on the run."

Kuan believes that Taiwan should have deregulated on a large scale soon after gaining accession to the World Trade Organization in 2002. Reducing trade protectionism and changing Taiwan's outdated regulatory mindset would have led industries and markets to naturally find ways to deal with international competition, he argues.

Instead, Taiwan's economy has been tied into knots by regulations and the conservative attitudes of some officials, he contends, and he therefore decided to turn the free economic demonstration zones into a "huge sign" promoting deregulation. The initial phase of the process will rely on administrative orders rather than legal revisions to ease as many restrictions as possible.

"Once the knots are untied, Taiwan's economy will immediately regain vitality," Kuan exclaims, predicting that the deregulation driven by the demonstration zones will increase Taiwan's output value by NT$30 billion and create 13,000 jobs by the end of next year.

A 20-year-old Strategy

Comparing Taiwan's planned economic zones with others found in Asia reveals several flaws, however.

The most obvious is that other countries, whether China, Malaysia, or South Korea, first consider their unique strengths, the structural needs of their economies, and how they are positioned before setting up a special economic zone within a defined geographic area "as an experiment." The easing of regulations in these zones and tax breaks are simply tools to help achieve defined goals.

But in promoting free economic demonstration zones in Taiwan, Kuan has made deregulation and even tax breaks and tax exemptions the goal of the economic zones rather than means to an end.

Scholars contend that Taiwan's proposed demonstration zones, lacking a long-range vision, not only have no focus but could easily become an open invitation to corporate deregulation and tax breaks, potentially increasing the risks of economic development.

National Taiwan University economics professor Kenneth S. Lin and former CEPD chairman Chen Po-chih both argue that if export-oriented Taiwan hopes to transform its economy, it can no longer rely on a longtime strength of Taiwanese companies: controlling costs. Instead, it will have to use branding, R&D and integrating industrial chains to create value and compete for "pricing power" in global markets. Yet the plans for Taiwan's demonstration zones are bereft of any policies that encourage industrial upgrading and transformation.

"To be honest, it's still just liberalization and expanding tax breaks, the same tricks Taiwan has been using for more than 20 years," Lin says. "This shows that when it comes to industrial transformation, the government has no ideas and no capability."

Even Rock Hsu, the chairman of the Taiwan-based Chinese National Federation of Industries who supports the demonstration zones, felt compelled to offer the government some friendly advice.

"We would be happy to see the government ease regulations and open markets, but the demonstration zones need to more clearly assess conditions in Taiwan, set development and investor recruitment targets and concentrate resources if they want to truly have the effect of stimulating the economy," Hsu says.

High Costs of 'Front Shop, Back Factory'

Aside from not having a clear direction, the planned free economic demonstration zones face another challenge: how to manage the "front shop, back factory" approach. If "back factory" benefits can extend to any manufacturer regardless of location, then how will questions of fairness between vendors inside and outside the zone be handled?

Also, if the demonstration-zone policy is not accompanied by supplementary measures, weaker industries could be dealt serious blows.

One example of the potential confusion: Vendors in the Pingtung Agricultural Biotechnology Park that Kuan so loves to cite will be allowed in the future to import tea leaves from Vietnam or other countries, repackage them and export them with the "Made in Taiwan" label. But questions abound. What processing needs to be done and what percentage of the product's total value needs to come from within Taiwan for the product to be described as "Made in Taiwan" or regarded as Taiwanese tea?

Also, food processors and major brands will be major beneficiaries of this market opening policy, but what will Taiwan's tea farmers gain? Supplementary measures that deal with these issues must be better defined, and the Council of Agriculture will have to be stricter in its process of certifying Taiwanese produce.

Unfavorable to Workers, Weaker Sectors

The planning for the demonstration zones also fails to assess the adverse impact that large-scale deregulation and liberalization would likely have on vulnerable industries and domestic workers.

"The free economic demonstration zones are like having several tax incentives hit the road very quickly at the same time," says Gu Yu-ling, the former general secretary of the Taiwan International Workers Association. "Business operators will welcome lower taxes, but workers will face increased competition from abroad, and even find themselves at a disadvantage tax-wise against overseas workers." (Foreign white collar workers will pay lower income tax rates than Taiwanese during their first three years in the country.)

"Up to now, the economic vision articulated by the Council for Economic Planning and Development does not provide a broad picture of Taiwan's overall development and lacks long-range planning and support for key industries. This policy simply amounts to another round of tax breaks for big conglomerates. On what basis can we (workers) be asked to accept it?

Time to Rethink the Plan

From the outside looking in, the government lacks direction and faces skepticism from the private sector and scholars, yet is still rushing to get the demonstration zones going.

Vice Premier Mao insists that "the government has an overall plan, but it wants to proceed step by step." He explains that the catalyst for the demonstration zones was Taiwan's desire to reach out into the world and improve its international competitiveness, goals that can only be met by aggressively signing free trade agreements with other countries. But those agreements will bring greater liberalization and challenge vulnerable sectors, potential problems that the government wanted to first test through the demonstration zones. Mao says that the results of the experiment will then provide an empirical basis for supplementary measures in the future.

Reforming outdated regulations and moving toward a fully open economy may in fact be the path export-oriented Taiwan must take to confront international competition. As currently conceived, however, the demonstration zones open so many back doors and have been so broadened in scope that they have lost their experimental value.

Asia's countries, national conditions and development stages vary widely, and the special economic zone policies adopted by South Korea, Japan, Singapore and Malaysia may not be suitable for Taiwan. But the government needs to quickly learn that behind other countries' enthusiasm for special economic zones is policy planning that actually involves clear positioning and an empirical basis for taking action.

Translated from the Chinese by Luke Sabatier