Wednesday, February 16, 2011

Charter cities

The idea of charter cities, originally promoted by Stanford economist Paul Romer, sparked a lively academic debate in the field of economic development. The idea of charter city rests on the premise of creating special reform zones within countries. The reform zone would not be governed by the prevailing system of formal and informal rules within countries. The concept of charter city would serve as an intellectual laboratory of ideas in which governments would be let to quickly adopt innovative system of rules. The purpose of charter cities is the empowerment of incentives in world's less developed countries to develop human capital skills, hence, to increase the level of productivity and real wages that could foster the increase in the standard of living. By and large, the core idea of building a charter city means building a city of about 1000 sq. kilometers in the unoccupied land of the host country and adopting an innovative system of formal and informal rules provided by the source country. The example of charter city include selling Guantanamo to Canada and turning the little piece of Cuban land into Caribbean Hong Kong by adopting a formal system of rules and governance based on limited government, strong rule of law and free market; and turning the new territory into manufacturing hub that could serve as a source of income for workers across Caribbean islands such as Haiti. The charter city would not only provide the opportunity for testing intellectual ideas and innovations but also migrational opportunities for individuals from world's most impoverished countries such as Haiti. The coordination of the charter city is managed by a triangle. First, the host country would provide the piece of land. Second, the source country would provide the infrastructure, human capital and ideas. And third, the guarantor country would provide the assurance that the charter would be respected by both countries.

The concept of the charter city has gained significant attention by development experts in discussing developmental malaise in world's least developed countries in Africa. The empirical evidence on Africa's underdevelopment is striking. It suggests a blinking interplay of corruption, institutional fragility and state failure. According to African Development Indicators, about 75 percent of firms in Cote d'Ivoire identify corruption as the major constraint in doing business. In Ethiopia, less than 2 percent of females enroll tertiary education. Moreover, the average Ethiopian female can expect only 7 years of total schooling. In Liberia, about 11 percent of married women partake a contraceptive use by any method. Hence, one third of young Liberian women, aged 15-19. In addition, 60 percent of Liberians live below $2 per day. In Mozambique and Sierra Leone, only 45 percent of young women are literate. A female at birth in Sub-Saharan Africa can expect to experience no more than 8 years of total schooling throughout her life.

The perennial question in the establishment of charter cities is whether the idea can serve as a source of good rules, promoting good governance through low-cost contract enforcement. Institutional fragility of states across world's least developed countries is largely the economic outcome stemming from wrong development diagnostics, mismatched policy choices and a rigid structure of formal and informal institutional arrangements which resulted in a myriad of bad rules and corrupt political leadership across the specturm of world's poorest countries. The general conclusion from the lessons of development policy is that in the last century, development policy failed to facilitate meaningful prescriptions for a permanent rise of GDP per capita. In particular, the misdiagnosis of essential development dilemma is not a consequence of technical failure in delivering concrete solutions to applied issues of economic development but a consequence of mismatched theoretical foundations which supplied wrong assumptions. Theoretical models of economic growth and development in late 1950s and early 1960s rested on the assumption on output per worker as an increasing and diminishing function of the capital per worker. Although the validity of the neoclassical growth theory remains undisputed, development policy and international aid donors failed to recognize that increasing the amount of aid does not lead to better development outcomes. In fact, the majority of Sub-Saharan countries experienced the relative decline of GDP per capita in the 20th century. In 1913, the GDP per capita of Ghana (in 1990 international dollars) represented 42 percent of the average GDP per capita of European periphery. In 2008, Ghana's GDP per capita represented merely 8 percent of the average GDP per capita of European periphery. By the available statistics, Algeria was the second wealthiest country in Africa, only after South Africa. In 1913, Ghana was the fourth richest society in Africa, only after South Africa, Algeria and Egypt. In 2008, Ghana's GDP per capita was ranked 20th in Africa, in the same range as Angola, Lesotho and Nigeria.

The question surrounding the emergence of the charter city is whether it can serve as a treatment to the contagious sclerosis of fragile institutional structure in failed states, marred by poor governance and the lack of law and order, causing the failure to enforce private contracts as to ensure the rule of law and provide the institutional impetus for sound governance and better formal and informal rules. A notable criticism of the institutional fragility in world's less developed countries pertains to the capture of the state by the political elites. The political elites in world's poorest regions have provided sufficient conditions for the capture of government and judicial system by incorporating a system of powerful informal arrangements through bloated corruption which consequently impaired investment and ultimately resulted in the expropriation of private property rights. The institutional chaos in the most failed states of the world culminated into behavioral adaption to bad rules. The sequence of harmful economic policies eventually seized upon poor development outcomes such as high rates of poverty, stagnating income per capita, low life expectancy and poor health and education indicators.

The foremost task of the charter city should facilitate the institutional decency to enforce private contracts without transaction cost barriers and ensure a robust system of the rule of law since better rules nonetheless depend on how informal institutions such as culture, habits and behavior embrace the virtues of free markets, limited government and the rule of law. Aside from the essential infrastructural arrangements, the provision of institutional conditions for living under a different set of rules does not necessarily imply sufficient prerequisites for the productivity growth that could, in the long run, transform the charter city from low-wage pool of unskilled labor into high-wage urban agglomeration. What is needed for a charter city to flourish is the acceptance of informal institutions of the liberal society such as the freedom of contract and the freedom from corruption. One should not hesitate that economic and personal liberties in world's poorest countries are plagued by predatory rent-seeking political behavior as well as contended against the principles of adherence to formal rules. Without a sensory adherence to these principles, it would be impossible to envisage the charter city as a solution to world poverty and underdevelopment.

For a charter city to provide a clear and cohesive framework of rules, it is essential to provide the credibility and predictability of rules. In early 1950s, Hong Kong was a small island chartered by the British who established a system of credibility over centuries. Hong Kong was the only place where Chinese workers were allowed to migrate from the mainland China. The credibility of the rules, emphasizing limited government over extensive government intervention, free markets over regulated command-and-control economy and the rule of law over political discretion and interest-group politics, proved vital in Hong Kong’s steady economic growth in the 20th century. In 1950, Hong Kong’s income per capita was around GBP 2,500. By 1997, the average income per capita rose to GBP 20,000.

The idea of building charter cities to boost income per capita by innovative framework of governance is a valuable alternative to the mainstream development policy. First, setting a charter city in regions such as Sub-Saharan Africa and Latin America would encourage seasonal and permanent migration flows from areas with low population density both on domestic and international scale. David McKenzie and John Gibson examined the impact of New Zealand’s Recognized Seasonal Employer program (link), aimed at encouraging seasonal migration from Pacific islands Tonga and Vanuatu to New Zealand, benefitting employers at home. The empirical evidence and policy conclusions suggest that seasonal migration is offering a triple win since a migrant, the sending country and the receiving country benefit from participating in seasonal migration program:
Nevertheless, there are several caveats to these conclusions. The first is that development is a long-term process, and some of the effects of the RSE may only materialize over many years of community involvement. These could include positive effects such as greater asset-building, investments and skill development if workers return for many seasons, as well as potential longer-term negative effects of continual absence of family members on family and community relations. Secondly, while the gains to households from this seasonal migration are large, they still pale in comparison to the gains from permanent international migration (McKenzie et al, 2010). A key policy issue is therefore the extent to which seasonal migration can or cannot eventually open up avenues for permanent migration. Finally, as with all evaluations, there is the question of how far the policy details and findings can be extrapolated to other settings and that it was developed drawing on lessons from experiences around the world should provide some external validity. As temporary migration programs are increasingly emphasized in policy discussions, there is likely to be plenty of scope for governments and researchers to work together in the future in assessing how well these lessons translate.

Second, charter cities would nevertheless spur the diffusion of knowledge into the countries of poor regions in the world. In its most distinctive form, charter cities would be similar to the role of small states in the global economy. For instance, consider Mauritius. Back in 1968, when the island gained the political independence from the United Kingdom, the economic prospects of the country were undermined by rapid population growth, rachitic productivity and overdependence on sugar as the only export industry. In addition, trade policy imposed high tariffs and import quotas to protect sugar manufacturers. Since it was impossible to dismantle the barriers to trade, the government of Mauritius responded by creating a virtual special export zone. Any foreign and domestic company could enter and exit the export zone by retaining the profits earned. Companies within the export zone operated under different rules with no trade restrictions such as tariffs, import quotas, voluntary export restraints etc. Hence, the only entry requirement for locating in the special zone was that companies manufacture only for exports as not to compete with domestic markets. The special export zone proved to be a success story. Productivity and employment rates increased sharply, boosting income per capita and standard of living. In 2010, Mauritius’s GDP per capita ($15,500) is the second highest in the region, only behind Gabon ($14,600). The experience of Mauritius with the special export zone and its consequent impact on the economic prosperity of the island, suggests that institutional competition ultimately rewards the institutional structure with better economic outcomes. The entire concept of the charter city is based on encouraging the institutional competition between charter cities and politico-economic systems in poorer countries where charter cities would be most likely to settle. Low initial level of income per capita in charter cities would encourage low-wage employment with unskilled labor. The experience of countries such as Mauritius, Singapore and Hong Kong suggests that favorable institutional features at the beginning stage of development result in better economic policies, ultimately leading to stable economic growth, higher standard of living and better education and health indicators. In Mauritius, the judicial independence from political influence has been enhanced by delegating the highest court of appeal to the British Privy Council, a royal judicial committee (link), full powers of judicial authority.

Many smaller countries in the 20th century, known for good development outcomes, have adopted roughly similar institutional impetus for economic growth and development. In Africa, countries with the highest level of economic freedom and the lowest perception of corruption, such as Mauritius, Botswana and Namibia, enjoy the highest level of GDP per capita in the African continent. In spite of the abundance of natural resources, Botswana adopted market-friendly economic policies in the second half of the 20th century, conducive to private enterprise and investment. According to World Bank, it takes 152 hours to pay taxes in Botswana compared to Sub-Saharan average of 315 days. In addition, a claimant in Botswana can expect to recover 63.7 cents per $1 from an insolvent firm compared to 8.4 cents per 1$ in Angola, 16 cents per 1$ in Niger and 0 cents per 1$ in Madagascar.

And third, charter cities would vastly improve the infrastructure of the residents, choosing freely to enter and exit the city. Households in countries such as Guinea still lack the access to electricity, forcing students to do the homework under streetlights and use the car park lights to review school notes (link). Despite being one of the largest receivers of aid per capita, Guinea still suffers from the lack of widespread access to electricity. One could hardly believe that the efforts pledged by international aid donors to reduce poverty and improve the standard of living across the African continent, were not sufficient. What created the black hole, such as the above in Guinea, is the institutional structure plagued by persistent corruption, political cronyism and bad governance, creating bad rules and wrong incentives. Charter cities would ingeniously cure the widespread persistence of misrule and political misconduct since the system of rules would be defined by the founding charter of the city. Good prospects of charter cities would require free entry and exit from the city as well as transparent and honest oversight of the respect for rules by independent judicial authority, managed by a guarantor country such as the United Kingdom, U.S. or Canada. In the proposed form, a typical charter city would become a manufacturing hub. In particular, it would enable access to low labor costs and significant economies of scale to technology entrepreneurs from rich countries as well as transparent contract enforcement, law and order and the security of private property rights. On the other hand, cities would enable millions of people from poor countries to migrate to chartered cities and seek employment opportunities in an environment, safe from corruption, political restraint, violence and bad governance. Hence, charter cities would provide a necessary input to the intellectual competition of ideas in economics, law and political philosophy and elsewhere to be implemented in chartered cities.

The concept enables social scientists and development experts a real-world experiment of ideas. Hence, charter cities could provide a safe haven for prosecuted individuals in poor countries, suffering from judicial errors, physical and military violence or illicit property expropriation. The UN estimates that, over the next few decades, 3 billion people will move to cities. The inflow exerts a growing pressure on urban agglomerations. The lack of basic infrastructure and the continuity of predatory misrule could cause a rapid growth of slums in larger cities which, by and large, are the main source of infectious diseases, HIV prevalence and youth crime since the absence of access to clean water, electricity and education are the major impediment to the improvement of development outcomes in poor countries. A charter city could flourish to become an impulsive alternative to the current state of overdependence on foreign aid. However, it should be unambiguously clear that adherence to good rules and governance requires a bold and decisive change in the set of informal behavior; in which corruption, crime and nepotism are doomed to the fullest possible extent by the full enforcement of private contracts and the rule of law.

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