Liberalizing Rent-Seeking - How Export Processing Zones Can Save or Sink an Economy

Abstract

Scholars commonly see rent-seeking as destructive, but governments sometimes introduce beneficial liberalizations as they try to maximizing their rents. The export processing zone (EPZ) is an example of a rent-seeking tool with the appearance of a policy for economic development. My model of endogenous tariff formation illustrates the incentives of interest groups to lobby for or against protectionism, which provides rents for the government. Trade liberalization causes the government to lose these rents. It can introduce EPZs as a way to liberalize the economy only partially, and thereby preserve some of its rents. My model implies that EPZs are beneficial if their political alternative is more protectionism, but not if the government would otherwise need to fully liberalize the economy. It also indicates that EPZs do not benefit an economy via backward linkages with the rest of the country. Rather, EPZs tend to divide the economy between exporters and import-substituting firms, with little connection between them. This divide only grows with time, as the EPZ sector‘s production becomes increasingly sophisticated and detached from protected domestic industries. Rather than backward linkages, the benefits of EPZs come in the form of a marginal improvement to a country‘s trade regime. I present a case study of the EPZs in the Dominican Republic based on interviews with EPZ investors and experts. The case study confirms the theoretical discussions.