The success of Russia’s Special Economic Zones in attracting investment to Russia’s far-flung regions beyond the capital remains an open question. Russia has yet to convince the international investment community that these zones are, indeed, “special.” Yet the country may be on the cusp of a ‘pivot to regions’ as it seeks to kick start economic growth, in which SEZs could play a key role.

Rockwool International President Eelco van Heel (left), Danish Trade Minister Pia Olsen Dyhr (center) at Tatarstan's Alabuga Special Economic Zone. Source: RIA Novosti / Maksim Bogodvid

Nine years have passed since the inception of Russia’s Special Economic Zones (SEZs), which are designed specifically to spread investment and economic growth to Russia’s regions beyond Moscow. SEZs are meant to attract and benefit foreign investors by offering tax exemptions and other incentives while benefiting Russia’s regions through Foreign Direct Investment (FDI) and a better quality of life.

However, their success remains an unanswered question. Russia is still struggling to convince the international community that their Special Economic Zones are indeed special. With so little updated, open-source information available in English on the internet for Western investors, this article examines whether Russia’s SEZs are good, bad or simply benign.

Disparities in Russia’s regions

An “insight report” on Russia prepared by Klaus Schwab’s World Economic Forum (WEF) entitled “Russia’s Regions: Drivers of Growth 4x4,” cuts to the chase: “Russia has made little progress on most measures of economic productivity, the quality of institutions, and the business environment.”

However, the report also cites a World Bank report that looks at the 83 individual regions of the Russian Federation and sheds light on noteworthy disparities.

Surprisingly, Moscow, Saint Petersburg, and the Novosibirsk Oblast are among the lowest-ranked regions in the World Bank’s 2012 Ease of Doing Business, in the Russia sub-national report.

Instead, WEF recommends Russia that seek vitality from other investment-attractive and well-performing regions, including (in order of rank): Ulyanovsk, Mordovia, North Ossetia-Alania, Rostov, Tatarstan, and Kaluga.

The Republics of Mordovia and North Ossetia-Alania were outliers because of their access to electricity. Neither region is among the top 20 in the category “ease of starting a business.” But the remaining four regions were suggested as holding great promise for foreign investment and having a potentially catalytic effect on sustainable Russian economic growth.

Keeping in mind Putin’s aim to put Russia into the top 20 of the World Bank’s “ease of doing business” list by 2018, and his acknowledgement that the causes of economic deceleration were “internal, not external,” it appears likely Russia is on the brink of turning inward, creating a ‘pivot to regions.’

Russia’s Special Economic Zones could be a key component of this transition. Created on paper in 2005 and tangibly installed in 2006, these so called Special Economic Zones – or SEZs – act as small cities within regions that incentivize foreign investors to do business by offering tax exemptions and streamlined market entry.

The SEZs offer a variety of different sectors, including: industrial and development zones, technological implementation zones, tourist and recreational zones, and port zones.

Potential investors are screened first regionally, then federally, by a board of “authoritative experts from various fields who evaluate the financial viability of both the applicant and the availability of its resources for the implementation of the announced plans, the role and importance of the project for the development of the real sector of the economy, and socio- economic benefits from its activities.”

In theory, SEZs are attractive, economy-boosting spheres of investment that provide modern infrastructure for primarily foreign investment. Empirically, however, the verdict over their success is still largely inconclusive. Many further contend that the success of the SEZs is ambiguous, citing less idealistic results.

The SEZs: Good, bad, or benign?

Among their advantages are some tax, import/export, and utilities incentives, “free access to the necessary infrastructure” and including electricity, access to Russia’s vast natural resources and skilled workforce. The SEZs “have led to the filing of more than 350 patents in Russia,” and have helped “residents save tens of millions of dollars in taxes and infrastructure.”

In late 2011, federal authorities made significant expansions of tax incentives for SEZ residents.

Regional authorities were also allowed to reduce regional income tax rate down to 0 percent, and the duration of tax incentives for business property increased from 5 to 10 years.

At the same time, the classification of SEZs into specific types (such as “industrial”) may have an adverse effect on other types of investment. In fact, purely industrial SEZs deter technology investment to that region. Though there is a skilled workforce, the workforce is shrinking. Though technology SEZs attract the most investors, the planned infrastructure is not enough. There is the lack of utilities and specialized facilities, including laboratories.

Many tourist and recreational SEZs are predominantly unsuccessful because of “underdeveloped transportation networks.” Basic infrastructure that would link a given SEZ with other regions is lacking, including roads and airports.

Meanwhile, the CEO of the SEZ in Alabuga, Timur Shagivaleev, has warned against expecting instant results. ‘We need to be patient with the implementation of major infrastructure projects,” he told RBC daily. SEZs are still in the “infantile” stages of development.  Even so, in the “Alabuga” and “Lipetsk” SEZs, “every budget ruble attracted three private” rubles.

Macroeconomic and political factors, of course, set the context for the success of Russia’s SEZs.

Although Russia is the highest ranked BRIC nation in 2014 in terms of the “ease of doing business,” its investment climate ranking is still relatively low. It numbered 92 out of 185 countries. A high perception of public corruption, according to Transparency International, must also be taken into account. Moreover, Russia is ranked 140th of the 178 countries on the 2014 Index of Economic Freedom.