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Free Zones as an Additional Option for the Cambrian Explosion in Government

April 10, 2009

Our first guest post comes from Michael Strong. He is the CEO and Chief Visionary Officer of FLOW, Inc., and the author of Be The Solution: How Entrepreneurs and Conscious Capitalists Can Solve All The World’s Problems.  There’s also a video of Michael giving these ideas as a talk. –Editor

Dubai Before and After Free Zone Economic Development

Dubai Before and After Free Zone Economic Development

I completely agree with Patri’s bleak analysis for the prospects of direct libertarian reform through the typical democratic electoral process (I’m open to the possibility of slightly more optimistic outcomes through rule changes, such as Clark Durant’s vote-saving proposal).

Historically, the fact of Hong Kong and the other Asian Tigers were among the most important bits of evidence on behalf of markets in the 1970s and 80s.  In the absence of such examples, the arguments of Milton Friedman and others would have been far weaker and would have had less of an impact.

Seasteading is an interesting and important option, but with real challenges.  There was an attempt at seasteading in the south Pacific in the 1970s or 80s–it was called the Republic of Minerva–in which military force was used to shut it down.  There was another well-funded attempt at seasteading in the Caribbean which was eventually abandoned because of cost of overcoming technical issues was far larger than anticipated.  But the fact that these and other attempts have failed does not mean that seasteading is not a good idea; many successful innovations were preceded by a long line of attempts that failed.

Another direction that I’ve been encouraging libertarians to consider is the option of a global free zone industry in which private corporations specialize not only in supplying physical infrastructure, but also in supplying legal infrastructure.  At present “free zones” and “special economic zones” range widely in terms of structure.  In some cases they are merely crony capitalist arrangements in which a developer gets a tax concession from government buddies.  At the other extreme is the Dubai International Financial Centre (DIFC), in which Dubai has hired a retired British judge to administer British common law within the 110 acres of the DIFC.  What is most distinctive about this arrangement is the precedent set by having a distinct legal system within the boundaries of a nation-state.  Moreover, this was explicitly done in order to attract investors – Dubai wants to become a financial center that can compete with London, NYC, Hong Kong, and Singapore, all of which run a version of the British common law OS.  They are running it very much as a business, pro-actively selling the quality of their legal system to prospective investors and developers, including making public commitments regarding the boundaries between UAE sharia law and DIFC common law, because they know that ambiguity regarding this boundary makes investors more reluctant to invest and businesses reluctant to locate there.  The result is that the DIFC has attracted about as much investment capital into 110 acres in the past five years as all of sub-Saharan Africa, exempting South Africa, combined during the same period.  (I have co-authored an article on this coming out in Economic Affairs in June).

Shenzhen Before and After Free Zone Economic Development

Shenzhen Before and After Free Zone Economic Development

Meanwhile, India is allowing for the creation of potentially hundreds of special economic zones across the country, deliberately modeling their approach on the success of the Chinese SEZs.  Again, there have been various challenges with the implementation of these SEZs, especially with regard to eminent domain abuses, that have forced the Indians to slow down the SEZ creation process.  Although there are leftist articles claiming that the SEZs in India amount to private governments, from our side I think there is not nearly enough autonomy.  That said, the vision of a large nation-state such as India deliberately opening up a market in SEZs would, if combined with serious legal autonomy in the creation of such SEZs, approximate the Cambrian explosion we desire.  In addition to commercial entities creating SEZs in India, Georgia Tech is creating a research park SEZ, an Indian co-op has created one for their operations, etc.  It is useful for the branding and experimental nature of the SEZ project in India to have diverse operators creating SEZs there.

Both of these developments, the DIFC and the Indian SEZ law, are legal innovations that have taken place in the past five years or so.  Strikingly, both U.S. academics and U.S. journalists have largely ignored these phenomena.  But in a world with some 200 existing legal regimes, many of which would like to improve their relative position in the global economy, power structure, and public prestige, it strikes me as plausible that we may see considerable growth in and experimentation with SEZs and free zones in the coming years.

This is a circumstance in which articulating a vision is useful; as more and more people understand that:

  1. Legal systems are the primary cause of poverty in the developing world.
  2. Turn-key legal systems that improve investment climate are readily available.

Then one can imagine a larger movement in the developing world in which more and more governments create SEZs with greater legal autonomy in order to attract investment and jump start their economies.

Moreover, as Bob Haywood, the ED of the World Economic Processing Zones Association points out, this strategy gets around the Northian problem of the “natural state.” Although earlier I complained about crony capitalist free zones, the fact is that the wealth creation opportunities of a free zone, especially a well designed zone with high quality physical and legal infrastructure, provides revenue streams which may be strategically divided up among not only the core investors/developers, but also among key stakeholders in government and the power structure that may need to be persuaded (i.e. paid off) to provide permission to create the zones.

Land values in Dubai and Shenzhen are between ten to a hundred times greater than they were prior to designation as a free zone.  Just as mundane zoning changes in U.S. cities, such as from residential to commercial, often result in a doubling or tripling of land values, a “zoning change” that moves land out of worthless land under Chinese communist law or standard 1980s era UAE law, into Hong Kong quality business environment, results in significant increase in value that grows as more investment is attracted and low value barren land becomes a world class metropolis with real estate values approaching those of other world class business cities.  This process creates gobs of wealth which can be used in various creative ways.

Mark Frazier has created Build-Operate-Transfer schemes in which the incentives are aligned such that powerful parties not only permit the creation of the zone, but have a long-term vested interest in its ever-growing financial success because they earn a larger percentage of the revenues (though still always a minority share) the longer the free zone is operating (see the appendix of this paper).  The ideal is to structure an incentive system in which it is more valuable to support the long-term autonomy of the zone than it is to undermine it.  Jobs and wealth creation in the region surrounding the zone, combined with revenue streams going to key elements of government at various levels, might do this.

I realize that a world in which Halliburton and Dubai Port Services create thousands of British Common Law SEZs that are commercially successful around the developing world is hardly anarcho-paradise.  But here again, this is where articulating a vision can change things.  Once it is more widely recognized that poverty is caused by bad legal systems, why settle merely on British common law?

At a minimum, vendors of commercial law will create ever more effective legal systems as they become credible vendors of such law.  Moreover, as a customer base develops, they will demand new features of the legal system much as customers everywhere demand new product features.  ZonAmerica, the first high tech free zone, based in Uruguay, has Tata and Intel as some of its main tenants.  As ZonAmerica replicates into Central America, presumably customers on the scale of Tata and Intel will be able to request improvements.  At present I know a wealthy entrepreneur who is interested in relocating his company and in investing $10-20 million in the creation of a country that has “the economic freedom of Hong Kong combined with the personal freedoms of Holland” (he is already interested in Patri’s project).  He is an essence a customer looking for a credible supplier of such a region, be it seasteading or free zone.  As these possibilities become more widely known, we’ll see more such customers, with diverse requests.

Without going further, once one has a global free zone industry with vendors of legal infrastructure responding to customer requests, many of which pertain to the issue of how to attract very talented human capital to an area, one can imagine an incremental approach to something that approximates a Cambrian explosion of governments.  The greatest obstacle to such a vision would be higher level governments, the U.N., WTO and other trade agreements, etc. crushing the expansion of legal possibility.  Already international trade agreements limit the permissible activity in free zones.

But this is where I’m pushing for idealistic NGOs to see zones as a solution to urgent global problems in order to create a sort of Bootlegger/Baptist dynamic that moves in our direction; I’ve spoken with Jane Goodall about creating a Chimpanzee saving free zone (habitat destruction and bushmeat consumption are the primary threats to chimps, both of which could be reduced through successful economic development), Paul Rice of Transfair on creating a “Fair Trade Certified” free zone, and Mark Frazier and I have written a paper on “Women’s Empowerment Free Zones” in which the wealth is used to support women and children, which has attracted some interest from women’s groups.  Mostly people think I’m crazy, but many of them gradually begin to take more of this seriously as they understand each node of the argument.  Bill Easterly, to his credit, when confronted with the economic development case I sketched out above, acknowledged immediately that development economists had pretty much ignored free zones and that that was a mistake (though the recent U.N. Commission on Growth Report, chaired by Michael Spence, puts in a good word for SEZs, as does Jeff Sachs’ End of Poverty, though neither recognize the vision sketched out here.)  I understand that Paul Romer is working on a related idea, but I’m not yet clear on the details of his project.

In any case, the more minds we have thinking and working on this path the better.  In many cases, the seasteading path and the “radically autonomous” free zone path share similar needs:  Both need more people who understand the need for a market in governments creating a larger, more public conversation around this possibility. This will lead to the possibility of scaling up considerably the market in governments on both the demand and supply sides, and finally, to a coalition that resists the obstacles that transnational organizations and treaties may create that would prevent a real market in governments from coming into being.

See the last chapter of my Be the Solution the “FLOW Vision for the 21st Century,” where I insinuate this vision into a larger context that many left liberals would find appealing.

If you enjoyed this post, you may be interested in others tagged Free Zones, or our whole blog (subscribe by RSS).

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