Caracas Chronicles

After a long debate, the Chavista-controlled 2020 National Assembly approved the Special Economic Zones (SEZs) Law in June 2022. The law was followed by Nicolás Maduro’s approval of five SEZs –Paraguaná, La Guaira, La Tortuga, Puerto Cabello and the military SEZ in Aragua– in August 2023 to “build” a “post-oil model.” 

While SEZs have nominally existed in Venezuela since 1973, the new approach seeks to create a legal mechanism to promote more foreign capital inflows on private domestic business and, hence, partially offset external financing restrictions linked to the United States’ sanctions over key public actors and entities in Venezuela issued since 2017.  However, considering all the economic and institutional frictions that the Venezuelan domestic market has experienced the last nine years, one can wonder: is this a good idea for Venezuela’s economy? Could a SEZ be a successful way to attract investment from abroad? The current proposed model for Venezuela does not bode well. 

Broadly, a SEZ is an ambitious project: a particular geographical area –usually linked to a specific activity, like tourism or foreign trade– that has rules and laws, for firms that want to develop their activities in these areas for exporting purposes, that are different to the nationwide legislation. This allows the firms to enjoy advantages that come from tax discounts, operational reliefs and a more flexible labor market, and others related.   

Because of this, it is not a coincidence that SEZs have been historically adopted by emerging markets as a way to promote trade and increase their capital inflows beyond the traditional sources (such as foreign direct investment, external financing, or multilateral support) while providing incentives to traditional industries to migrate to technologically-intensive activities or high-end inputs exports.

Perhaps one of the most well-known international experiences with SEZs are the so-called maquiladoras, manufacturing operations developed over Mexico’s border with the U.S. during the 1960s. In this model, local industries took advantage of a cheaper labor force to increase domestic sales to the U.S. market and to reduce migration.  Nowadays, these firms are in the top 100 of global car parts suppliers, as well as key input producers for the aerospace, electronics and alternative energy industries.

Moreover, since the SEZs policy could demand requirements beyond the financial ones –like hiring a given fraction of local labor force, accomplishing a minimum exports value’s threshold or offering employees’ high-qualified capacitation– their outcomes would involve more than investment or boosting exports. Most specialized literature suggests that SEZs could bring mid-term improvements to host markets in terms of foreign trade, domestic firms’ performance, labor productivity and human capital accumulation with second round effects over domestic output. In that sense, encouraging manufacturing and services through this approach in Venezuela seems to be a good idea.

SEZs meet Venezuela’s tax inferno

But the proposal gets more challenging once we get into the details. 

According to official releases, the “new” Venezuelan SEZs (thereafter, VSEZs) would include some of the most common features of international SEZs: lifts on customs services, special procedures for operational formalities, preferential loans to investors, specialized training centers for workers, among others.  However, there is one key aspect that would distinguish the Venezuelan experience from the international cases: the chosen tax incentives. 

Whereas mostly all foreign forms of SEZ usually offer direct tax cutoffs, the VSEZs fiscal incentives will be concentrated on drawbacks. That is, the return of a portion (or total) of imports/direct taxes previously paid by investors over an (so far) open-ended period.  

In the context of Venezuela’s current macroeconomic environment, this issue could represent a hole in the quest of getting foreign investment through VSEZs.  With a weekly inflation rate near to 3%, it is almost impossible to keep the drawback real value over time, unless it’s quickly returned and/or issued on foreign currency. 

Even if it’s the latter case, dollar drawbacks will lose value under the so-called Venezuelan dollar inflation if these resources are reused locally.  Without a doubt, this issue would tackle foreign firms’ prior incentives to enter these VSEZs.

Whereas mostly all foreign forms of SEZ usually offer direct tax cutoffs, the VSEZs fiscal incentives will be concentrated on drawbacks. That is, the return of a portion (or total) of imports/direct taxes previously paid by investors over an (so far) open-ended period.  

Firms in a VSEZ will also face the impact of domestic price distortions on other aspects of their businesses. For instance, if part of the drawback is in bolivars, assessing the impact of these tariffs will be critical for any investment, especially for those investors who expect long-term returns.  Moreover, higher prices in Venezuela would encourage VSEZs’ workers to demand larger wages, while firms could face more operative expenses related with hired domestic services, input suppliers and any other aspect weighted for any other expenditure closely related to local inflation.  In addition, an SEZ does not eliminate the lack of rule of law and legal protection that promotes external outflows, a common feature among local firms nowadays.  

According to the World Bank’s Doing Business index, Venezuela was ranked in 2020 as the country –of a total of 190 countries– with the worst conditions to start a business and the 2^nd worst in terms of tax payments.  In fact, since almost all of these VSEZs firms will work under a highly dollarized environment, many of their transactions could be exposed to larger taxes like the well-known IGTF tax on dollar transactions. 

Likewise, three additional critical aspects should be considered for any investor by the time he or she would want to enter the local market.  Firstly, a scarce and costly domestic credit, which is still below the required levels to sustain a larger increase on domestic spending: around 20% of the GDP, well above the current 1.5% that credit currently represents. Secondly, the collapse of basic services, which have exposed local firms to unexpected disruptions of water, electricity, and car fuel supply, especially outside main cities (where most of the approved VSEZs would operate).  Finally, despite their scope and past licenses, the private sector in Venezuela and its ties with global credit markets are still hurt by OFAC sanctions’ overcompliance despite a temporary relief. 

Due to all these issues, it seems it would take more than an SEZ project to promote a larger and more sustainable recovery of the Venezuelan market.  However, there are still few chances for private business to grow and to raise Venezuelans’ living conditions, at least partially.  Here, the real question will be: with no foreign loans or investment, for how long will it be possible to keep the current path? Certainly, the VSEZs do not give us a pleasing answer.