Towards a Theory of Free Economic Zones

This paper presents a theory capable of analysing the welfare effects of a wide variety of institutional innovations which have in common that they involve the deregulation of, or the lowering of tariffs and taxes on, a range of economic activities that can be effectively separated from the regulated, taxed and protected industries of which they are a part. The partial deregulation of economic activities in this manner will be shown to lead to the expansion of trade, but also to involve potential costs of locational diversion of trade and negative externalities. In the context of the debate over deregulation the development of free economic zones can be seen as a practical compromise that generates powerful local interest groups pushing partial deregulation against the well-known in­ terest groups opposing general deregulation.