How ZEDEs Can Make Honduras Prosperous

By: Contributor - Mar 20, 2015, 2:18 pm

By Michael Strong

Español Why isn’t Honduras prosperous? Why do more than 100,000 Hondurans leave each year and risk their lives to get to the United States, where most of them will become illegal immigrants with no rights?

Conversely, why is China becoming prosperous so rapidly? In the past 20 years hundreds of millions of Chinese have escaped poverty. Averages urban wages in China today are more than five times what they were 20 years ago. What can be done to ensure that working-class Hondurans earn five times as much 20 years from now?

The Chinese Special Economic Zones (SEZs) were key to this burst in prosperity. As Nobel laureate Ronald Coase and economist Ning Wang show in How China Became Capitalist, the SEZs created the conditions under which the Chinese working class began the path towards dramatically higher wages.

(Michael Strong)
(Michael Strong)

The free zones in Honduras were created in Honduras in the late 1980s. At the time it was predicted that they would create more than 100,000 jobs. At their peak they did exactly that. But due in part to competition from China, they did not result in significant wage growth. How can Honduras up its game so that it can bring higher-quality, higher-wage jobs to the country?

Traditional free zones and special economic zones have been on balance a spectacular success at reducing poverty around the world. In Mauritius, Mexico, Ireland, China, and elsewhere zones have begun the booms that later resulted in greater economic liberalization and increased economic growth. Jeff Sachs lists export-processing zones as one of the very few successful approaches to reducing poverty. The management guru Peter Drucker was more blunt: zones are the only anti-poverty program that works.

But traditional zones only reduce taxes and regulation. This is often an important step in attracting investment, creating jobs, and creating prosperity, because most developing nations have byzantine tax structures and/or excessive regulation. The next step in zone development consists of the creation of zones that provide access to higher quality law and adjudication. Before explaining why the Honduran ZEDEs represent the state-of-the-art zone program, let’s first clarify why traditional zones have been needed.

The Need for Zones to Reduce Taxes and Regulation

While anti-capitalist intellectuals believe that “neoliberal” reforms have resulted in jobs leaving the developing world to go towards “unregulated” developing nations most developing nations are drowning in red tape.

Fifteen years ago, Hernando de Soto documented the tortuous process of opening a legal business in developing nations such as Peru and Egypt. Since then the World Bank has been publishing the “Doing Business” index annually. The top five nations:

1. Singapore
2. New Zealand
3. Hong Kong
4. Denmark
5. Korea

The bottom five:

185. Chad
186. South Sudan
187. Central African Republic
188. Libya
189. Eritrea

Prosperous nations are prosperous in large part because they make it easy to do business. Poor countries are poor largely because they make it difficult to do business. Honduras is ranked 104th — hardly a “libertarian paradise.” (Partisans should note that it is possible to have a substantial welfare state and be very business friendly. Note that Denmark at fourth and Norway at sixth are both ranked more business friendly than the United States, which comes in at seventh).

Honduras is poor because the legal system of Honduras does not adequately provide for the conditions that result in prosperity. Without exception, every nation in which entrepreneurs have been free from predation and regulatory excess has become prosperous. A recent World Bank report concludes: “respect for and promotion of economic freedom and civil and political rights are, on average, strongly associated with a country’s per capita income growth over the long run.”

Hong Kong and Singapore, the two nations with the highest levels of economic freedom, have gone from poverty to prosperity in the past 50 years. In 1960 they both had a GDP per capita of roughly US$400, while the Honduran GDP per capita was roughly $200 (in today’s dollars). Today, Hong Kong’s GDP per capita is $38,000 and Singapore’s is $55,000. Honduras’s is just over $2,000. Had Honduras had as much economic freedom as Hong Kong and Singapore continuously from 1960 onwards it would be a first-world country today.

Access to Global Legal Systems Enjoyed by Multinationals

Unsophisticated advocates of economic freedom sometimes claim that prosperity is simply the result of reduced taxes and regulations. This interpretation of the data fails to recognize the importance of having access to a legal system that supports entrepreneurial capitalism. Stanford scholar Edgardo Buscaglia summarizes the key features of such a legal system:

Basic elements that constitute an efficient judicial system are … relatively predictable outcomes within the courts; accessibility of the courts by the population, regardless of income level; reasonable time to disposition; and adequate court-provided remedies. Increasing delays, backlogs and the uncertainty associated with expected court outcomes have diminished the quality of justice.

He goes on to explain the multiple shortcomings of Latin-American legal systems:

Everywhere in Latin America courts are unable to perform their basic function as mechanisms for the interpretation and application of the law. The inability to satisfy this demand manifests itself in increasing backlogs and time delays observed throughout the region.… We can here identify substantive, procedural and organizational factors explaining the increasing presence of corrupt activities within the courts.

While these problems are certainly grounds for improving the training and funding of judicial systems (and to that extent reducing taxes could make the problem worse), there is no reason to prevent ordinary citizens from having access to other judicial systems in the meantime.

Multinational corporations in Honduras already have access to their choice of law internationally: any doing business in Honduras can choose to have its legal disputes adjudicated in Delaware, Texas, Holland, Spain, or anywhere else they please. Why not provide ordinary citizens with the same access to choice of law through arbitration?

This is the genius of the ZEDE system: it will allow ordinary citizens access to competing legal systems and jurisdictions. Citizens within a ZEDE may still choose the Honduran legal system in contracts if they so choose — but they may also choose to use a lower cost, more efficient legal option. A Honduran tech entrepreneur may choose to take advantage of California’s cutting-edge IP law. A Honduran finance entrepreneur may choose to utilize London’s world-class financial law.

ZEDEs the Next Stage of Zone Development

Moreover, while the ZEDE program is an important innovation, it is following in the footsteps of an earlier highly successful zone program: the Dubai International Financial Centre (DIFC), which has been so successful that it is now being replicated in Abu Dhabi.

In 2004, the Dubai government wanted to create a global financial system, but it realized that the Sharia legal system of UAE would not attract international finance. With a brilliant stroke of insight, the rulers of Dubai created the DIFC, a 110-acre zone featuring British common law administered by a respected British commercial law judge. This zone has since attracted billions in Foreign Direct Investment (FDI) in the past decade, which is why Abu Dhabi recently announced that they would create a similar zone.

The Honduran ZEDEs break new ground in providing not only the economic zone model that has proved successful around the world but also the legal zone model that has proved successful in Dubai. The ZEDE structure adds two new dimensions, administrative and political. Mark Klugmann, who designed much of this structure, describes this approach as a “LEAP Zone,” a legal, economic, administrative, and political zone, to differentiate ZEDE-style zones from earlier economic zones and from the DIFC legal-zone model.

The exact implementation of the administrative and political aspect of the ZEDEs remains to be seen. That said, observers of the ZEDE program should start with a recognition of the extraordinary success of earlier special economic zones, on the one hand, and the legal zone of Dubai, on the other.

Given the proven upside of many earlier zone programs on which the ZEDEs are building, observers should focus on ensuring that the administrative and political aspects of the ZEDE program are executed appropriately. But uninformed criticisms of the ZEDE development strategy amounts to sabotaging the greatest hope the Honduran poor have of a significantly better life.

Michael Strong is CEO of Radical Social Entrepreneurs and cofounder of Khabele Strong Incubator. He also has an equity stake in a corporation which may submit a proposal to develop a ZEDE. Follow @flowidealism.

Edited by Fergus Hodgson.