Dr. Aradhna Aggarwal on SEZs, their role in economic development, and India's growth ambitions

ELI5/TLDR

Special Economic Zones are walled-off bits of a country with friendlier rules, meant to attract foreign factories and let their know-how leak into the rest of the economy. The leaking is the hard part — most countries fail at it, ending up with shiny enclaves that earn dollars but don’t transform much else. India never bothered to use its SEZs the way Korea, Taiwan, and China did, and now we may have missed the bus on the labour-intensive manufacturing that lifted those countries. Aggarwal’s blunt take: India’s services boom has driven up wages enough that we can’t compete with Vietnam or Bangladesh in textiles anymore, so we should stop trying and aim for the low-skill, high-tech assembly slot that Foxconn-style work offers.

The Full Story

What an SEZ is actually supposed to do

The pitch for a Special Economic Zone is simple. Carve out a patch of land, give it better infrastructure and lighter rules, lure in a Foxconn or a Samsung, and watch the magic spread. The “spread” is the whole point — economists call it a backward linkage, which is the boring name for a very specific thing. A foreign giant arrives. It needs screws, packaging, plastic moulding, logistics, security uniforms. Local firms start supplying these. Over time the locals pick up new techniques, better quality control, the discipline of supplying a global brand. Eventually one of them spins out and competes on its own.

That is the success case. Aggarwal points out it isn’t the only kind of linkage. There are forward linkages, where SEZ firms sell into the domestic market and locals get to study the new product. There are labour linkages — engineers leave Foxconn to start their own thing. There are demonstration effects from sitting next door to a multinational and watching how it manages a factory. And there are network effects through industry associations.

The problem, she says repeatedly, is that none of this happens automatically.

“It is very difficult to do that kind of thing. But you actually create conditions that is more important.”

Why most SEZs fail

Aggarwal’s diagnosis comes in three layers.

First, the SEZ itself can be too small, too poorly located, or too isolated. If only foreign firms are allowed in, the locals never even get co-located. If the zone is the size of a postage stamp, no scale, no spillover.

Second, policy barriers. In most countries, including India, an SEZ firm cannot easily sell into its own domestic market without paying full import duty, which kills forward linkages. India in particular forces SEZ-to-domestic transactions in IT services to be done in foreign exchange, which sounds technical but means a Bangalore firm wanting to buy from an SEZ firm next door has to scrounge up dollars. Hainan, by contrast, just declared its free port a place where 30%+ value addition lets goods enter the Chinese mainland duty-free. Forward linkage solved by decree.

Third, and this is the one she keeps circling back to: domestic firms aren’t ready. They lack the technological capability, the quality discipline, the timing. So Foxconn just imports the components and the SEZ becomes an enclave — a sealed-off pocket that earns foreign exchange but doesn’t transform anything beyond its fence.

The two things that actually worked

Aggarwal’s research splits Asia into two groups. Northeast Asia — Korea, Taiwan, China — figured out the linkages. Southeast Asia — Thailand, Malaysia, the Philippines — never did. The difference wasn’t ambition. All of them attracted foreign capital. The difference was R&D and direct intervention to build domestic capability.

Korea had a dual regime. Inside its free zones, light, labour-intensive consumer goods, attracting foreign exchange and employment. Outside, a heavy-industrialisation push protected by import substitution, building chaebols like Samsung and Hyundai. The two complemented each other. India, she points out, also did import substitution but never used its SEZs as the export-and-employment release valve. Kandla, supposedly Asia’s first export processing zone, was largely ignored.

Taiwan went a different route — it used its SEZs to build up small and medium domestic firms. The state and provincial governments deliberately trained local SMEs to supply the multinationals. Penang in Malaysia did the same on a smaller scale, and it stuck. Today, Aggarwal says, Taiwanese SMEs are so technologically capable that the multinationals inside the SEZs are coming to them for ideas.

China combined both. Forced joint ownership and technology sharing on the foreign companies. Built parallel “high-tech zones” of trained domestic workers right next to the SEZs, so the spillover had a place to land. Scale was the China twist — where Taiwan made small companies powerful, China built giants like Huawei and BYD.

“China actually had a huge model… They are churning patents after patents every year. So I mean, that kind of attitude has to be there if you really want to promote your brands.”

Thailand’s lesson, which is also Mexico’s lesson

Both countries pulled in massive foreign investment in autos. Neither produced a globally known domestic car brand. Aggarwal says the trap is being too dependent on FDI and skipping the R&D step. You can build production capability — the boring assembly-line muscle of making something to spec — without building technological capability, which is the part where you design the next thing yourself. The shorthand she uses is OEM to OBM: you have to graduate from being an Original Equipment Manufacturer to being an Original Brand Manufacturer. Most countries never make the jump because making the jump requires sustained R&D spend, and sustained R&D spend looks expensive and pointless until, twenty years later, you don’t have a Samsung.

South Korea is the world’s second-largest R&D spender after Israel. That’s the answer.

India’s PLI scheme — good intent, soft execution

India’s Production Linked Incentive scheme is the current attempt to attract high-value-added FDI. Aggarwal is supportive of the intent and dry about the execution. The 2025 evaluation showed many firms couldn’t meet targets and a chunk of the incentive money never got disbursed. Her point isn’t that incentives are wrong. It’s that incentives without follow-through achieve nothing.

“Merely by giving incentives, the targets, the kind of policy intentions, the objectives cannot be achieved… you have to really interfere.”

She makes a distinction between the soft part of policy (announcing it, allocating money) and the hard part (figuring out why companies aren’t hitting targets, fixing the actual bottlenecks, training the bureaucrats who administer the scheme). India is good at the soft part. It is reliably bad at the hard part. The current geopolitical mess — tariffs that change weekly — makes uncertainty itself a tax on industrial growth, and uncertainty is harder on factories than any specific bad policy.

The Dutch disease argument

This is the most provocative part of the conversation. India’s textile and apparel exports zoomed after 1991 liberalisation, then slowed sharply after 2011. Aggarwal says we shouldn’t be surprised. Vietnam and Bangladesh have lower wages and preferential trade access to Europe (Bangladesh’s “Everything But Arms” scheme lets it export to the EU duty-free). India has neither.

But the deeper claim is harder to swallow: India’s services boom has structurally raised wages across the economy, the same way an oil discovery raises wages in Norway. That’s Dutch disease — a sector grows so fast its high wages bleed into other sectors that can’t sustain them. Translation: India can no longer be a cheap-labour country. The cheap-labour bus has left, and we ran for it too late.

“I personally feel that India has lost the opportunity. It has lost the bus of promoting labor-intensive goods. Now we have to skill our people and we have to really focus on skill-intensive industries.”

She links this back to a 1956 choice. India picked heavy industrialisation and elite higher education — IITs, IIMs — while neglecting school education. So we ended up skill-rich at the top, illiterate at the bottom, with no proper middle of mass-employment manufacturing. When the IT services wave came in the 1990s, our skilled top caught it, and the wages it paid pulled the whole economy upward. Manufacturing, smothered by bureaucracy, never had a chance to catch up.

So what now? Low-skill jobs in high-tech industries

Aggarwal is hopeful about one specific thing — the Foxconn model in India. Not because it builds high technology here (it doesn’t, yet), but because assembling iPhones is a low-skill job inside a high-tech industry. People will take it. They won’t take garment work. The aspiration ladder has shifted. Dixon and Tata are emerging as ancillary players, which is the early shape of a real backward linkage.

She also points to “servicification of manufacturing” — modern manufacturing is increasingly software, design, AI-enabled processes. India’s services strength can plausibly plug into that, if we figure out how to bridge the two.

On free trade agreements and geopolitics

India was historically allergic to FTAs because previous studies showed we tended to lose. The recent burst of activity — EU, UK, Australia, Oman, the interim US deal — is driven by the China-Plus-One reshuffle. Aggarwal’s caveat: FTAs without domestic capability just turn you into someone else’s market. China-Plus-One is real, but most of the redirected investment is going to Vietnam, not India. We have to actually build value chains in pharma, autos, semiconductors, renewables — not just announce policies.

Her concluding worry is that everyone is now playing the same industrial-policy game. The US, China, India, Cambodia, every country is trying to build domestic capability. Manufacturing as a share of GDP is declining in most developing countries. Deindustrialisation is happening despite all this effort. India, she thinks, is in a good spot to fight the tide — large skilled population, mature economy, Indian-origin executives running many global companies. But the political will and the implementation muscle aren’t there yet.

“We need really to have that kind of push from every quarter to make it a success.”

Key Takeaways

An SEZ’s purpose is technology spillover, not foreign exchange or employment alone. If it’s an enclave, it has failed.
There are at least six kinds of spillover: backward linkages (subcontracting), forward linkages (SEZ-to-domestic sales), labour mobility, manager mobility, demonstration effects from co-location, and information networks. Backward linkages get all the attention; the rest get neglected.
The single biggest reason SEZs fail at spillover is that domestic firms are not technologically ready to supply the multinationals. Foxconn imports because the local screw-maker can’t hit the spec. Fixing this requires deliberate state-led capability building, not just incentives.
Korea ran a dual regime: free zones for light export industries, heavy industrialisation behind protectionist walls outside. The two complemented each other. India had only the second half.
Taiwan’s success was built on training small and medium domestic firms to supply multinationals — a deliberate provincial-government effort, especially in Penang and Hsinchu.
China combined Taiwan’s capability-building with scale, plus mandatory technology-sharing clauses on foreign firms, plus parallel “high-tech zones” of trained domestic workers next to its SEZs.
The OEM-to-OBM transition (Original Equipment Manufacturer to Original Brand Manufacturer) requires sustained R&D spend. South Korea is the world’s second-largest R&D spender after Israel. Thailand and Mexico, despite massive FDI, never made the jump because they skipped this.
“Soft policy” (announcing schemes, allocating budgets) is easy. “Hard policy” (implementation, evaluation, fixing bottlenecks) is what most governments fail at. India’s PLI scheme illustrates this — well-intentioned, weakly executed.
Dutch disease applied to India: the services boom raised wages economy-wide, making labour-intensive manufacturing structurally uncompetitive against Vietnam and Bangladesh.
India’s 1956 choice — heavy industry plus elite higher education, with school education neglected — produced a skill-heavy top and an illiterate base, missing the middle that mass manufacturing needs.
Hainan’s model: 30%+ value addition inside the free port allows duty-free sale into the Chinese mainland. India still charges full duty on SEZ-to-domestic sales, killing forward linkages.
India’s IT-sector quirk: SEZ-to-domestic transactions must be settled in foreign exchange, which actively blocks linkages.
The Bombay Santa Cruz EPZ produced India’s branded jewellery industry (Gitanjali and others) via one entrepreneur, Rajiv Seth, learning techniques from a Japanese order. Sri Lanka’s Brandix textile cluster was similarly seeded by one American — Martin Trust.
The China-Plus-One redirection is real but mostly going to Vietnam, not India. India’s FDI did rebound to $81 billion this year after a decline.
“Servicification of manufacturing” — software, design, AI replacing manual steps — is where India’s services advantage may plug into manufacturing, if anywhere.
Aggarwal’s policy ask: a separate, dedicated implementation strategy for industrial policy, including training the bureaucrats who actually administer the schemes. She notes that during the SEZ rollout, the implementing officials often did not understand the policy themselves.

Claude’s Take

Aggarwal is the kind of expert who has seen enough policy failures to be allergic to optimism but enough successes to know what worked. The conversation is dense in a useful way — she keeps tying every claim back to specific countries and specific decisions, so you can disagree with her conclusions without doubting the inputs.

The strongest part is the Northeast vs Southeast Asia split. It’s a clean explanatory frame: production capability without technological capability gets you Thailand. You stay rich-ish, dependent on foreign capital, no brands, no leverage when the next FDI wave goes elsewhere. R&D is the gear that lets you escape, and India is barely engaging the gear.

The Dutch disease argument is the most contested part and probably the most important. There’s a counter-case — that India’s services boom is concentrated in a few cities and a few crore people, and that the wage spillover into rural manufacturing wages is actually small. Plenty of economists would say cheap labour is still here in Bihar and UP, just not where the SEZs are. But Aggarwal’s deeper point survives the quibble: aspirations have shifted. People who would have taken garment-factory jobs twenty years ago now want office work or, failing that, Foxconn-style assembly. That’s a cultural fact even if the wage data is murky, and it constrains what’s possible regardless of the textbook answer.

Her endorsement of low-skill-in-high-tech as India’s best shot is uncomfortable but probably correct. Every other path requires either time we don’t have (decades of textile dominance) or institutional capacity we haven’t shown (Korean-style R&D-led brand building). Plugging into the iPhone supply chain is a humble ambition, but it’s also the only one anyone has actually executed at India’s stage of development.

Score is 8. Loses points for the conversational structure — the interviewer is solid but the discussion meanders, and a few thoughts get cut off mid-sentence. Gains them back for being one of the more honest expert conversations on Indian industrial policy: no boosterism, no doomerism, lots of specific country examples, and a willingness to say “you missed the bus” out loud.