Why Charter Cities? A Reply to Tom W. Bell

In his response essay, Tom W. Bell lays out some of the reasons for favoring charter cities and other types of special jurisdictions as tools for reform (hereafter charter cities). The primary reason, he argues, is that competition between jurisdictions can lead to better outcomes. While competition is an important reason for favoring charter cities, it is one of several. The reasons for charter cities, in order of importance, are 1) the importation of good governance, 2) low cost experimentation in governance, and 3) jurisdictional competition.

There is rough consensus on what leads to economic development: rule of law, property rights, and an open business environment. As Hong Kong and Singapore demonstrated, a country (or city) with rule of law, property rights, and an open business environment can rapidly grow into a high-income country. The challenge is that many countries face political constraints which make them unable to implement rule of law, property rights, or an open business environment. In such circumstances charter cities are a political tool.

Charter cities are a political tool to overcome gridlock. By using narrow but deep reforms, particularly when they are applied to unpopulated areas, the public choice problems that often vex reforms elsewhere are minimized. Further, among for-profit charter cities, the logic of collective action is reversed. There is a clearly identifiable benefactor from such reforms, namely the developer, who is incentivized to lobby for reforms to increase their land values. This incentive alignment can help disrupt stagnant political systems which are captured by powerful interest groups.

The second justification for charter cities is experimentation. Importing good governance assumes that these particular reforms would ideally be implemented at the country level, but for political reasons they cannot be. However, there exists a different set of reforms as well, which are not clearly positive or negative, but are worth testing. Charter cities can be used for experiments to test the potential benefits of such reforms.

Glen Weyl and Eric Posner, for example, argued for a Harberger tax in their new book, Radical Markets (listen to my podcast with Glen Weyl here). Under a Harberger tax, people self-assess the value of their property. They pay taxes on their self-assessment, which incentivizes them to self-assess a lower value. However, if anyone desires to buy their property at the self-assessed value, they must sell it, incentivizing them to self-assess at a higher value.

It is unclear whether a Harberger tax will increase efficiency. However, it represents a powerful alternative to the current property rights system of freehold, which dominates most liberal democracies. Imposing a Harberger tax on a liberal democracy would be disruptive, causing social disorder. However, by implementing a Harberger tax in a charter city, it would be possible to test its effects with minimal disruption. If successful, the Harberger tax could be copied elsewhere.

The third reason for the importance of charter cities is competition. It is less important than the previously listed reasons because jurisdictional competition operates in fundamentally different ways from intra-firm competition.

First, it is a non-sequitur to argue that jurisdictional competition requires additional jurisdictions. Industrial organization means that different industries have different optimal firm sizes. The optimal firm size for jurisdictions could be larger than it currently is, given the economies of scale to national defense and internal markets. Alesina and Spoalore argue that states trade off the benefits from such economies of scale with the heterogeneity of preferences in larger jurisdictions.

Arguing that competition requires additional jurisdictions requires evidence that the current size of political units is inefficient. Given low international barriers to trade, as well as relative peace, this is an argument I am sympathetic to. However, it is not enough to simply assume that the need for increased competition implies the need for additional jurisdictions.

Second, it is not clear that the charter city “like” success stories result from jurisdictional competition. Hong Kong, for example, was a lucky accident resulting in British rule and in particular administrators, namely John Cowperthwaite. Singapore’s success was largely due to Lee Kuan Yew. Shenzhen resulted from the bottom up demand of Hong Kong businessmen looking for investment opportunities coupled with Deng Xiaoping’s ascent to power. Such examples fit within creative destruction in the broad sense, but hardly within intra-firm competition as it is typically understood.

Also from this issue

Lead Essay

  • Mark Lutter points to the success of China’s Shenzhen Special Economic Zone, and of many others like it, as a model for the extension of economic liberalization elsewhere in the world. While economic reforms could not happen nationwide, their demonstration at the local level built support for new ways of thinking and doing business.

Response Essays

  • Prof. Sarah Moser is skeptical of libertarian interest in special economic zones, startup cities, and seasteads. She notes that many of these projects as undertaken in the real world are being run by untrustworthy and illiberal regimes. It is therefore doubtful that they offer prospects for better governance in the long term. And it is unseemly for the self-described advocates of liberty to go begging favors from such regimes. The success of China’s Special Economic Zones is unlikely to transfer elsewhere, owing to demographic and geographic features unique to China and to certain of its regions.

  • Tom W. Bell says that in special economic zones, the secret to success is competition in governance. There’s no magic to being a special economic zone; zones may be governed either better or worse than other areas. But when the zones have to compete for residents and businesses, they will have to answer some tough questions about what sorts of legal and public service options the public really wants. And there is an incentive to improve.

  • Lant Pritchett doubts that charter cities can do much to help the developing world. If a developing state already has good institutions, the model is useless; if it has bad institutions, then it will plunder or otherwise undermine the experiment. Total factor productivity has been a difficult problem for economists, and much about it remains mysterious. But China appears to be the only place in the last forty years where special economic zones have worked, and this suggests that they are not as promising as their proponents think.