Charter Cities Aren’t Necessarily Last Resorts

Lant Pritchett responds to my lead essay in part by reviewing the intellectual history that led to charter cities. Namely, there was a realization of the importance of institutions, combined with pessimism about institutional change and the existence of low-level institutional equilibria. Charter cities therefore “came onto the development agenda as an intellectual last resort.” They are a tool which can disrupt an existing low-level political equilibrium.

Pritchett then gives three reasons why charter cities are unlikely to succeed. First, the commitment problem. Charter cities require a credible commitment from a host country for the legal autonomy necessary to succeed, a commitment which they are unlikely to achieve. Second, there is the political space within which charter cities could be successful. Some countries, South Sudan for example, are too dysfunctional for charter cities. Third, a zone cannot be a city. High productivity places require a complex set of inputs making special purpose special economic zones unfit for generating sustained economic growth.

The commitment problem is the usual objection I hear from economists. The host country needs to both pass legislation which creates the legal autonomy necessary for a charter city, then credibly commit to respecting such legislation, otherwise no one would invest. This creates a conundrum as potential host countries which can credibly commit often do not need charter cities. Nevertheless, I think the commitment problem is overstated for several reasons.

First, the norms around sub-national legal autonomy are changing. For example, ten years ago the Seasteading Institute was founded to pursue legal autonomy in open waters, as it was assumed that no host country would be amenable to the level of legal autonomy they desire. They have since shifted their strategy, signing a memorandum of understanding with the government of French Polynesia. On a different note, Sri Lanka relinquished control of a port to China for debt relief. There are a handful of other examples which cannot be shared due to space and privacy constraints, but we are approaching an inflection point in governance, and governance forms which were previously unthinkable are now being thought.

Second, new city projects are proving that, at least for the real estate side, fear of future expropriation is not the binding constraint. There are dozens of multi-billion dollar new city projects around the world. Most such projects are privately led or are public-private partnerships. The entrepreneurs I speak with also don’t put such a high emphasis on the commitment problem, suggesting that economists overstate its importance.

Third, there are a number of ways to tie the hands of the host country regarding the legal autonomy of the charter city. First, successful institutional change requires the allegiance of the ruling elite. For a charter city, this means ensuring that the ruling elite has an economic interest in the success of the charter city, either by having them build factories there, own land, or otherwise invest in the project. Second, the International Court for the Settlement of Investor Disputes can be used by charter cities to reclaim wrongly appropriated property. Third, it is possible, as Romer suggested, to use international treaties to bind a country. Either a guarantor country could administer the charter city, or a country investing with their sovereign wealth fund could demand a treaty, or an IGO could use their treaty to protect the legal autonomy of the charter city.

Pritchett’s second objection involves the potential political space for charter cities. I agree that charter cities aren’t applicable in all circumstances. Some countries, Rwanda for example, which is already growing rapidly, would see little benefit from a charter city. Other countries, the Democratic Republic of Congo for example, are too violent to implement a charter city. Nevertheless, there is a large political space within which charter cities could have a meaningful impact.

Latin America, for example, has long been stuck in the middle-income trap. Charter cities could help them escape from it. Africa has many countries which could benefit from charter cities, including Kenya, Nigeria, and Zambia. Further, it is important to note that for charter cities to be successful they don’t need to have “good” institutions. They only need to have “better” institutions than the alternative. A charter city in Honduras, for example, would be a success if they could implement Mexican or Salvadoran institutions, much less American institutions: El Salvador’s per capita income is 50% greater than that of Honduras.

I am not sure I fully understand Pritchett’s third objection. He writes, “high productivity places are those that can bring together the longer and longer lists of capabilities needed for complex production. This therefore draws a distinction between the creation of special-purpose economic zones to facilitate the production of a very specific item (e.g. a zone for producing athletic shoes) and the creation of a large space, like a city, that can reap the economies of agglomeration.” I agree; this is why I choose to focus on charter cities, rather than special economic zones.

Special economic zones typically create level effects, increasing efficiency on certain margins. They rarely create growth effects. To benefit from economies of agglomeration, there needs to be a sufficiently large population with a diverse economy. That is best developed in a city.

However, I would push back on Pritchett’s emphasis on high productivity places. Charter cities do not have to be high productivity per se, they only need to be higher productivity than the alternative. I believe the best model for most countries interested in charter cities is not Dubai, but Shenzhen, which slowly worked its way up the value chain, beginning with highly labor-intensive manufacturing.

Pritchett concludes by pointing out that Dubai, the most successful “charter city” since Shenzhen, is a real estate development. That is an important point. The charter cities of the future are not purely political projects, but also real estate projects. Real estate creates a sponge by which the benefits of improved governance can be captured, incentivizing developers to improve governance. Charter cities are both political and business projects.

I do not think that Pritchett is right that charter cities are an “intellectual last resort” to avoid the pessimism implied by institutional analysis. Sarah Moser’s essay demonstrates that charter city like projects are being built across the world. However, assuming Pritchett is right, he would be wise to remember that the Ghostbusters saved the world by crossing the streams.

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.