Should Struggling Countries Let Investors Run Their Cities?

Honduras contemplates creating a first-world oasis in the middle of its weak economy.
Women scuffle with a soldier during a protest near the National Congress in Tegucigalpa January 25, 2013. (Jorge Cabrera/Reuters)

Last month, the Honduran Congress approved the creation of independent commercial cities called Employment and Economic Development zones (or "ZEDE" for their Spanish acronym). Supporters of the ZEDEs, including Honduran President Porfirio Lobo Sosa, hope they will offer an alternative to the corruption and governance challenges that hamstring Honduras's economy. They believe that replacing parts of Honduras's ineffective regulations with new rules and institutions overseen by international experts will stimulate much-needed competition, economic growth, and foreign investment.

Striving to create sort of a Hong Kong on the Caribbean is controversial, however, and detractors fear that the ZEDEs will fail, undermine the country's already weak institutions, and also hurt the land rights of marginalized indigenous groups.

Honduras is one of the poorest and most insecure countries in Latin America: an estimated 60 percent of the population lives below the poverty line, and it has the highest per-capita homicide rate in the world, according to the UN. Income inequality, broken institutions and corruption are the norm. Honduras also suffers from political instability and a culture of impunity, which were reinforced by a recent military coup. Past reform efforts have failed in large part because of opposition from a small group of entrenched elite families that control key state institutions and entire sectors of the economy.

Against this backdrop, the government has sought out new approaches to tackling Honduras' problems. It started to explore the concept of charter cities in 2009 after the president's chief of staff viewed a TED talk by the famous economist Paul Romer on the subject.

According to Romer, autonomous economic zones attract investment, create jobs, and promote economic activity. They do so by adopting separate, investor-friendly regulatory environments governed by other countries with proven track records (e.g. the U.K. or Canada) instead of the often-corrupt local institutions. A zone's adoption of another country's regulatory regime provides the stability, predictability, and transparency that businesses seek out. It also allows the host nation to experiment with new (and hopefully superior) regulatory regimes before deploying them throughout its territory.

Romer rejects the notion that such zones are neocolonial because they do not rely upon two key underpinnings of colonialism -- coercion and condescension. Local leaders remain sovereign. They elect to invite another country to assist with the administration of the zone, specify the scope of authority ceded to the other country, and determine how that country is to be compensated. Romer cites Mauritius's decision to use the Privy Council -- the U.K.'s highest court -- as the court of final appeal in Mauritius as a successful example of outsourcing certain administrative procedures to other countries. The arrangement promotes investment in Mauritius by giving investors confidence that any disputes related to their investments will be resolved fairly by the experienced and neutral Privy Council as opposed to less-respected local courts.

The Lobo Administration seized upon this concept as a potential answer to Honduras' economic and political woes, and it has worked over the past three years to build such zones on Honduran territory. In early 2011, the Congress passed a law allowing for the creation of ZEDEs, which was subsequently struck down as unconstitutional by the Supreme Court.

A new law was drafted to address the concerns of the Supreme Court and included a series of constitutional amendments to allow for the creation of such zones and the grant of autonomous judicial power to them. That law was approved on June 12 and Honduras is now moving forward with the establishment of the first of 12 planned ZEDEs. Local residents are scheduled to vote on them in November 2013.

According to Shanker Singham, an international trade and competition expert advising interested parties on this initiative, the ZEDEs are inspired by Romer's ideas but add significantly to them. Honduras is focused on how an autonomous regulatory regime can unleash the forces of competition and generate substantial wealth creation.

The structure of the ZEDEs ensures that Honduras itself--not only outside investors--derives maximum benefit from them. As investors and businesses begin to locate their activities in a ZEDE, its land becomes more valuable (just as it did in Singapore, as that small nation became a hub of economic activity), which generates wealth for landowners, including the local government, investors, and so on. Similarly, the economic activity within the ZEDE generates profits in the form of taxes, concession fees, and equity stakes in new ventures. The government receives a sizeable share of this money. Honduras would also benefit from the new jobs created in and around the zone through existing international businesses that relocate there and from new businesses that form there. Economic growth is possible because the vested interests that traditionally benefit from lack of competition (and oppose reform efforts) do not exist in these as-of-yet undeveloped areas. After all, no powerful family would have had any reason to use its money and influence to obtain, for example, a monopoly in a barren part of the country devoid of commercial activity.

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Eli Sugarman is a fellow at the Truman National Security Project and a former foreign-affairs officer with the U.S. State Department's bureau of international security and non-proliferation.

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