Will Honduras Become the Dubai of Central America?

By: Contributor - Apr 22, 2014, 2:18 pm

By Domingo Soriano

EspañolHong Kong, Dubai, Luxembourg, Singapore … for years, these countries or territories have been ranked among the most prosperous of the world. They don’t have much in common. Some are between two large rich states (France and Germany), while others are thousands of miles from the rest of the first world. Some have natural resources (oil, in the case of the UAE), others have had to reclaim land from the sea to make room for their growing population. Some of them were colonies, but not of the same traditional powers. And most were poor 70 years ago.

For Honduras? Vista al centro financiero de Dubai desde el Burj Khalifa, el edificio más alto del mundo. Fuente: Belén Marty
View of Dubai’s financial center from Burj Khalifa, the world’s tallest building. Source: Belén Marty.

Actually, their only common geographical feature seems to be their size: all of them are small. Of course, because of their wealth, they are also among the most densely populated areas in the world. In Hong Kong, for example, 7 million people (roughly the same as Bulgaria) live in just 1,000 square kilometers (half the surface of Guipúzcoa).

What they do share, is their general approach to economic policy: they are based on free markets, with an institutional environment that promotes entrepreneurship, talent development, and investment.

Upon locating these territories on a world map, it is easy to notice that they are more or less scattered around the globe, with one exception: the American continent. Yes, there are some Caribbean islands that could be considered financial havens or paradises. But there is no equivalent to Hong Kong or Dubai, which are not only attractive for their tax benefits, but have become focal points for investment and important business centers. Perhaps this is in part because there is no urgent need for them: New York, Chicago, or Toronto, are well established cities that offer business-friendly environments.

But the fact is that at the time of writing, one of the most exciting projects in the economic history of Central America is about to become a reality in Honduras: the Employment and Economic Development Zones (ZEDE). The idea is to create special areas with a particular fiscal, administrative, and legal framework. The aim is to attract investment, and make the small Central American country the new Dubai or Hong Kong.

In a time when trade between the two great American rich neighbors — Canada and the United States — and among countries of the Southern Cone — Brazil, Colombia, Peru, and Chile — is gaining momentum, the ZEDE aims to play on their geographical advantage. On Thursday, one of its promoters, Mark Klugmann, spoke to Libre Mercado newspaper in Madrid. There has been much speculation on similar projects in the past, but it seems like the Honduran case is for real.

When Will the Action Take Place?

Areas of economic development are not a new concept, they have been around for some time, to the point that they have come to be known as “free cities.” But for one reason or another, not all of them have been successful.

Klugmann believes the time has come for launching them this same year in Honduras. He assures that “There’s lots of optimism.” The project was approved by “a very large and diverse majority of 128 Members [in the Congress of Honduras], and we got more than 100 votes. There was a Constitutional reform, and a treaty with Kuwait has been ratified. The discussion is no longer limited to domestic legislation, there is now also an international element.”

In fact, in February, a delegation of Korean businessmen visited the Central American country and reviewed possible locations. The most likely seems to be in the southwest of the country, near the Gulf of Fonseca. Klugmann, a former economic adviser for Ronald Reagan, even believes this could mark the beginning of a regional renaissance: “President Juan Orlando Hernaández has put this issue on Central America’s regional agenda. The idea is that other countries in the region also launch their development zones, and that they collaborate with each other.”

How It Will Happen

Free cities, libertarian havens … the future of these zones has always been the subject of imaginative speculation, partly because of their novelty. But their promoters believe they will be much more mundane than many believe. Listening to Klugmann, one gets an idea halfway between Hong Kong and the Dubai International Financial Centre. That is, a place with some autonomy regarding business rules (taxation, labor market, courts, administration, etc.), but that is still part of a sovereign state in any other aspect.

“Hong Kong is an interesting case,” says Klugman, “it exists within the sovereign territory of the People’s Republic of China (PRC). But if you invest there, there is no need for you to understand the legal framework of the PRC. There is actually a legal system that operates under the principles of common law, judges have an international background, and many come from other countries. This allows the investor peace of mind in the sense that there won’t be a higher national political force that can favor one interest over another. They are confident that there is a system for solving disputes, for enforcing contracts, protecting property rights, and maintaining stable rules of the game.”

In the case of Dubai, its emir “wanted to create a business area and thought that the economic element on its own (duties, taxes, labor standards, regulations, etc.) would not be enough. So in 2006, he introduced a strong institutional and legal element: courts, judges, judicial culture, etc. It is as if he had issued a declaration, saying: ‘In this area there will be no national laws or judges, there will be a common law system.’ He then hired very distinguished judges from Singapore, New Zealand, and Great Britain.”

The Key Elements of the ZEDEs

As noted above, economic facilities for investors and a stable legal system are two fundamental aspects. But promoters say the ZEDE project would not be complete without the administrative and political elements.

Klugman argues that “the administrative element is also critical. It determines the difference between what is written on paper and what actually happens in practice. It is all about an efficient and transparent executive power. For example, in Hong Kong one deals with the civil service, whose rules and culture resemble that of the English Civil Service. In Singapore, the government doesn’t make you feel you will become elderly while waiting for bureaucratic procedures. There are countries where the executive branch is slow, bureaucratic, corrupt … other countries have big problems of insecurity or public order, problems in all the branches of the legal system.”

Finally there’s the “political stability and transparency” element. This may be the big question mark for the project. Right now, the Honduran government is very involved, but who says that in the future there won’t be a a populist government in power that tries to expropriate or control the ZEDE?

Klugmann mentions two instruments that mitigate this risk. On the one hand, the international treaties to which the Honduran state will be bound. On the other hand, the strong support the project got in Congress. He believes that once the project is functioning and generating wealth, there will be no reason for anyone to oppose it. But he admits that without stability, nothing will be possible.

“The investor wants to know whether everything will change after the next election. For example, in Switzerland you can invest in a project without having to worry about who will be in power in a couple of years. The stability of the model, and the guarantee that it will be protected against populist attacks are very important.”

Tax Free?

The first thing that comes to mind when talking about the ZEDE, is a tax haven for businesses and residents. But this is not what the ZEDE project is all about.

Yes, taxes will be low, but Klugman ensures this won’t be the most appealing aspect of the project: “What is interesting is that most of the productive capital of the world is not in tax-free zones. It seems a paradox. The favorite instrument of developing countries to attract investment is a policy of ‘you don’t have to pay taxes here.’ There are 3,500 tax-free areas around the world. But the largest investment projects are in the United States, Canada, Switzerland, Sweden, Singapore, etc.”

He uses a down-to-earth example to illustrate this principle: “Imagine a world in which restaurants compete exclusively in terms of price. In this world, the extreme case would be a restaurant that offers free food. But that would not be the dominant model, because a restaurant that gives food away most likely will use low quality ingredients, slow staff, its tables will be dirty … Meanwhile, next door, someone opens another restaurant with such delicious food and great service that people are willing to pay for it. In the real world, businesses compete in terms of quality. Although, of course, prices must be in line with the quality of the offering.”

Klugmann emphasizes that the key for a successful investment project is the stability of the legal framework, which is not incompatible, of course, with a very attractive tax system.

“If a company is planning to make an investment that will generate an estimated income of US$100 million, its highest risk is losing everything through an expropriation, or due to legal problems … in this context, imagine a 10 percent tax on earnings, which amounts to 10 million per year. Yes, the company in a way is ‘losing’ 10 million per year, but on the other hand it is securing the initial investment of 100 million, because taxes finance governmental functions that ensure economic stability, sound institutions, a good legal system, etc. Imagine we tell an investor: ‘You are not going to pay taxes, but we cannot ensure a reasonable level of security.’ That is what we will guarantee with the ZEDE: a transparent legal system, security, political stability, judges … and also a very attractive tax and economic model.”

This article first appeared in Libre Mercado.

Translated by Alan Furth.