Socratic Michael Strong

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Intervention Report: Charter Cities

First,  it is a landmark advance in effective altruism that this issue is being addressed.  Regardless as to whether "charter cities" or "reform zones" is the favored approach, the big headline is that EA is recognizing the case that:

  1. Economic growth is critical for creating global prosperity.
  2. Improving institutions may be, along with human capital development, the most effective means of increasing economic growth rates.
  3. Subnational, zone-based approaches are likely to be more tractable approaches to improving institutions than are nation-based reform efforts.

A broad-based, ongoing discussion that recognizes these three premises is a huge advance.

That said, the single greatest limitation of this piece is the Romer-centric charter cities framing.  That is not the fault of the authors - Romer's advocacy of charter cities did serve to focus attention on this kind of reform path.  

But the more relevant history for what you describe as "reform zones" is that zone practitioners had realized by the early 21st century that the next stage of zone development, beyond reduced taxes and regulation, was moving beyond traditional SEZs to next generation zones featuring higher quality law and governance.  I was first introduced to this perspective in 2005 by Mark Frazier, a zone consultant with decades of experience who is now chairman of the Startup Societies Foundation.  A year later I met Bob Haywood, at the time ED of the World Economic Processing Zones Association, who had independently come to a similar perspective.

Around 2007 I convened a conference on zones as a strategy for economic development.  Bill Easterly, one of the attendees, acknowledged that development economists had pretty much ignored zones.   He thought that this had happened simply because development economists were focused on examining nation state data sets and running regressions on various variables.  Zones and zone-based reforms were not visible in the nation state data sets (though the case of China was making it increasingly evident that that had been a major blind spot).

In the meantime, Dubai had developed the idea for the Dubai International Financial Centre (DIFC) in 2002 and opened for business in 2004.  The DIFC, featuring British Common Law in 110 acres within a sea of UAE sharia law, is the best modern model of a distinctive zone based legal system functioning within a very different legal system.  It has been so successful that today Dubai is ranked as a top 10 global financial system.  Abu Dhabi announced a similar model in 2013 and opened it in 2015.  So can a zone-based enclave with a distinctive legal system function successfully?  Yes, the DIFC, Abu Dhabi Global Market, and now the Honduran ZEDEs are all proven models, with the DIFC almost 20 years old with a successful replication in Abu Dhabi well established at this point.

From the perspective that the real innovation is not a city-scale charter city a la Romer, but merely next generation zones with distinctive law and governance, this "reform zone" approach is actually well established.  True, these early versions were not residential developments.  But insofar as the more important proof point is to demonstrate that a distinctive legal environment that is more attractive to business can be grafted on to an existing jurisdiction, that piece has been functioning for some time.  

This perspective also informs the history of what actually happened in Honduras in 2012.  Octavio Sanchez and Mark Klugmann had been developing similar zone based concepts well before Romer's 2009 TED talk.  I was introduced to them by Giancarlo Ibarguen, former president of UFM in Guatemala, who had also been thinking along these lines.  Between meeting Mark Frazier in 2005 and Romer's TED talk in 2009, I had had similar conversations with Kevin Lyons, Ricardo Valenzuela, Spencer MacCallum, Patri Friedman, Robert Himber,  Fred Kofman, Gabriel Delgado Ayau, Guillermo Pena, Shankar Singham, Leif Smith, James Bennett, and dozens of other people.  There was a very active ecosystem of thinking and debate along these lines that preceded Romer but which did not have his elite mainstream intellectual status.

Octavio and other Honduran advocates saw that Romer's reputation would be useful in obtaining mainstream credibility.  But they were also concerned with his unrealistic city-scale vision and his neo-colonial approach to governance by means of a "guarantor state."  I met with Yusuf Amdani, the leading industrial zone manager of Honduras who had had an earlier conversation with Romer, who was trying to raise $5 billion dollars.  He asked Romer if had the first billion.  Romer replied, "No."  He said, "This is not going to happen."  A $5 billion charter city with an external guarantor was insanely unrealistic and everyone (except Romer) seemed to know this.

Romer met with President Lobo in late 2011 and shortly afterwards announced that he had been appointed chairman of the Transparency Commission in an interview with The Economist.  But no notes to that meeting have ever been provided.  A website, registered in Palo Alto, where Romer lived at the time, designed to appear as if it was an official Honduran government website, listed the Transparency Commission members which had been announced in The Economist article, including Romer as chairman.  But as far as anyone can determine, Romer unilaterally had put up that website.  Reason's article, "Blank Slate State," provides an account here.  

In September 2012 I signed an MOU with the Honduran government to develop a RED jurisdiction.  Our approach was to develop a very tiny piece of land with a new common law legal system in place, similar to what Prospera has ultimately done (I'm an advisor and have a tiny equity stake in Prospera).  Before signing the MOU, I asked the Honduran government to sign an affidavit saying that no Transparency Commission had been appointed, which they did.  From their perspective, one informal conversation between Romer and Lobo, after which Romer put up a website, obviously did not constitute a legal appointment of any kind whatsoever.

They had not publicly denounced Romer's website in the 10 months it was up.  Their explanation was that if it had led to progress it would be worthwhile.  At the same time, they were impatient to make progress, we had a viable small-start plan, and Romer had a completely unrealistic neo-colonial mega-project.  So they signed with us, Romer "resigned" from a Transparency Commission which had never been formally appointed, and a few weeks later the Honduran Supreme Court ruled the RED legislation unconstitutional.

My belief is that Romer has been largely silent on charter cities since then is because this history is awkward for him.  The sympathetic reading is that he was impatient himself to make progress.  Even if the Honduran government had wanted to follow up with his conversation with Lobo and formally appoint his Transparency Commission, it could have taken months or years to do so.  So he took it upon himself to do so -without any formal Honduran government authorization (he has claimed he was authorized to do so, but has never produced any written documentation of any kind).

Because of the immense moral upside for all of this - I definitely believe in the higher estimates of EA outcomes once we have a clear, widely supported path to reform zones - I forgive Romer.  He is unusually entrepreneurial, original, and courageous among elite academic economists.  Compared to the randomistas, he is unmistakably heroic.  He put his not-yet-awarded-but-almost-certain Nobel prize at risk by venturing into charter city advocacy.  That is courage and moral integrity.

But at the same time, having been on the inside of the failure of the original "charter city" incident in Honduras, the public narrative that it failed due to "corrupt institutions" is simply false.  That is not what happened.  Anti-capitalist journalists and academics are prone to play up an insidious plot because they have strong priors in that direction.  But it was more of a comedy of errors than any kind of corruption.  Honduran corrupt elites have their well-established rent seeking relationships that go back generations.  They had no interest in this project at all - it didn't make sense to them, just seemed crazy and irrelevant.  The people who supported this were all driven not by profit seeking, but rather out of a clear understanding of the role of law and governance in creating prosperity and allowing freedom (some were more on the creating prosperity side, some more on the libertarian freedoms side).

Finally, I emphasize at the beginning the importance of economic growth, the role of institutions, and the strategy of sub-national zone based reforms as a means of providing higher quality institutions because these key elements are not widely recognized among intellectuals.  Insofar as anti-capitalist journalists and academics continue to be widespread, they actively undermine acceptance of reform zones.  I see spreading much greater intellectual sophistication around the role of institutions in creating prosperity as a key means of moving beyond simplistic pro-capitalist vs. anti-capitalist debates into a pragmatic, action-oriented movement towards bringing billions of people out of poverty.  

Whatever challenges the path of reform zones faces, what other realistic path do we have for improving institutions and accelerating growth for billions of the global poor?

(Regarding the widely varying success of SEZs - Read Lotta Moberg's, "The Political Economy of Special Economic Zones.  Tl;dr privately financed zones are more likely to be successful than are crony capitalist, politically-motivated government financed zones, plus a lot more nuance worth reading for serious SEZ students).