The Blank Slate State
Will an isolated corner of Honduras become the new birthplace of liberty?
It is easy to take one look at Honduras and write it off as an irredeemable mess. The small Central American nation, wedged between the Pacific Ocean and the Caribbean, is the murder capital of the world, with the U.N. reporting over 80 homicides per 100,000 people in 2011, compared to slightly over 30 in Colombia and under 10 in the United States. Its average annual income of $4,300 per capita is below that of the Congo. According to the U.S. Agency for International Development, 65 percent of its people are living in poverty. The World Bank ranks Honduras 125 out of 185 on its "ease of doing business" list, below Uganda.
"Honduras is a country in meltdown, as homicides soar, drug trafficking overruns cities and coasts," the Associated Press reported in January. "Many streets are riddled with potholes, and cities aren't replacing stolen manhole covers." As Robert Naiman, policy director of the U.S. advocacy group Just Foreign Policy, told the A.P., "In many ways, the state is no longer functioning."
But where most observers see a dysfunctional state, a few dreamers see hope for an experiment that may upend our notions of what a state can accomplish. For the last few years, libertarians and other futurists have gazed upon this misgoverned mess of mountainous jungle and imagined a clean slate for innovations in political and economic growth. Honduras, they believe, can become a laboratory for creating wealth-producing institutions that can then be replicated worldwide. The only catch: To become a 21st-century trailblazer, Honduras—or at least a small territory within it—must become, well, not Honduras.
A Sci-fi Dream
The notion of carving out an area inside an existing country with its own set of laws—economically freer and less complicated for businesses and citizens to navigate—has been popularized under many names: charter cities, free cities, future cities, and LEAP (legal, economic, administrative, and political) zones. The notion of zones for trade and economic activity freer than the nation-states around them dates back as far as the Greek island of Delos in the second century B.C. and the Hanseatic League in the late Middle Ages. Hong Kong and other Chinese "special economic zones" are more direct ancestors.
The idea seems to be gaining steam in the early 21st century, with policy entrepreneurs from all over the political spectrum hatching their own versions. Each variant proceeds from the insight that bad government hurts an economy's prospects more than most people realize, yet can be escaped easier than you might imagine. Good governance, the theory goes, can blossom even within a bad system.
In beleaguered Honduras, a version of the free cities idea has been percolating for more than a decade in the mind of 37-year-old Octavio Sanchez, currently the chief of staff to President Porfirio Lobo. When he was a teenager, Sanchez told an NPR reporter in a story that aired in January, his favorite amusement was imagining futuristic policy solutions, which he wrote down at age 16 in a sort of political science fiction book of imagined bulletins from the Honduran government of 2050. Sanchez never believed his country's poverty was due to some kind of inherent national defect. "Many all over the world," he told NPR, "don't understand we are poor not because we are dumb; we are poor because of institutional arrangements, not because of lack of capacity to imagine things."
Sanchez, then working his way up the Honduran political pyramid, began musing over how to evade or change the clotted mass of laws, regulations, and practices he saw strangling the economy. In 2002, when Lobo, for whom he already worked, was head of the Honduran Congress, Sanchez started advancing the conversation with an American development consultant named Mark Klugmann, who latched onto the idea of what he called LEAP zones. Klugmann's insight was that piecemeal attempts at enacting market reforms over entire economies tend to generate opposition from powerful coalitions of entrenched interests. Why not try doing the reforms all at once, but on a smaller level? Klugmann sold both Sanchez and Lobo on the notion that Honduras should have its own Hong Kong—a more market-friendly island within the stultifying state. That would make Hondurans richer quicker.
After a period of slow germination, fortune came to the project in 2009 from an unlikely source: a constitutional crisis. The Honduran military, with the approval of the country's Congress and Supreme Court, sent President Manuel Zelaya into exile because he was pushing a referendum that would have allowed him to remain in office beyond the four-year limit prescribed by the Constitution. Lobo won the next presidential election, taking office in early 2010, and Sanchez became his chief of staff, finally in a position to make his teenage political science fiction come true.
Around this time Sanchez discovered a YouTube video advocating something remarkably similar to the idea he and Klugmann had been hashing out for years. It was a TED talk delivered in July 2009 by Paul Romer, a respected development economist who teaches at New York University's Stern School of Business.
Romer is the pioneer of "new growth theory," emphasizing the importance of ideas and technology in economic development. Back in 1997 he was named one of the 25 most influential Americans by Time magazine, and he has long been considered a contender for the Nobel Memorial Prize in Economic Sciences. Romer had begun staking his reputation on a concept he called "charter cities," launching an organization of the same name to promote it.
In his viral TED talk, Romer used North and South Korea as a vivid example of how the rules under which a people operate affect their wealth and development. Haiti, he said, is an example of how governments can stifle growth by being too weak, not just by being too strong. He used China and its market zones, such as Shenzhen (modeled on the economic success of Hong Kong), as an example of how different rule zones within one polity can generate wealth and combat poverty. The Chinese/British alliance in Hong Kong, he claimed, "did more to reduce world poverty than all the aid programs we've undertaken in the last century."
Romer had been trying to convince various nations to carve out a charter city and had even received a commitment from Madagascar to launch one in 2008 (to be operated by the South Korean corporation Daewoo). But Marc Ravalomanana, the president Romer had convinced, resigned under pressure in 2009, and the Madagascar project died. Sanchez, delighted to find such a renowned intellectual on the side of free zones, invited Romer to participate in Honduras' attempt to create them.
Into the RED Zone
The Honduras project began gathering steam and attracting international attention in 2011. In January and February, the Honduran Congress amended the constitution to allow for the creation of free cities. In July it passed a statute defining "special development regions" (SDRs)—in Spanish, regions especial de desarrollo, a.k.a. RED zones.
The SDRs would be "autonomous legal entities" with "their own system of administration," armed with the power to "promulgate their own rules and have their own judicial entities." The national government in Tegucigalpa would retain control over defense, foreign affairs, elections, ID documents, and passports. Honduras would not be responsible for any debts or financial commitments of the SDRs and could not tax them. The SDRs' own tax levels were capped by statute at 12 percent for individual income, 16 percent for corporate income, and a 5 percent sales tax.
Judges in the zones would have to be approved by a two-thirds vote of the Honduran Congress, but the jurists themselves need not be Honduran. SDR residents would be free to "contractually consent to arbitration of judicial proceedings outside the SDR's judicial entities and arbitration forums." Ports and airports would be the SDR's responsibility, and it could collect whatever related fees it saw fit.
Initially, the Honduran president would appoint a governor and a Transparency Commission to oversee the charter cities; the commission would then appoint governors, as well as a consultative council that could veto a governor's rules, plus an audit committee. According to Romer's Charter Cities website, the governors' powers would disappear in favor of a popularly elected "normative council" after the SDR had reached "population and economic benchmarks" set by the Transparency Commission.
Romer began telling the press he was chairman of the Transparency Commission, a role in which he would help guard against the skullduggery and corruption that so many associated with the Honduran government and business world. His involvement seemed a natural fit. But as Romer prophetically if jokingly warned in his TED talk, "Don't send academics out in the wild."
From the beginning, there were conflicts of visions between Romer, the Honduran government, and the libertarian activists and theorists attracted to the free cities model. Romer imagined not a small, organically growing project but one built from the beginning to house 10 million mostly immigrant residents (more than the population of the whole Republic of Honduras, now 8 million), on the theory that such size was necessary for economies of scale.
Romer's grand plans ran afoul of Honduran politics. The Honduran Congress included in its initial legislation a requirement that 90 percent of SDR employment go to Hondurans, a rule that could be amended in specific cases. Worse, contends Michael Strong, a major player in the free cities movement, Romer's vision was impractical and relied too much on a sort of pre-central planning of how the zones would function, not allowing for the organic growth Strong prefers. Romer also wanted to contract out operations directly to a foreign sovereign, which smacked of neocolonialism to some. "We wanted a small startup near existing urban areas," says Strong, "where one could prove the concept that improving law will attract capital" without having to spend the tens of billions upfront that Romer's plan required.
Strong was at the vanguard of a loose community of mostly libertarian policy and business entrepreneurs excited by Honduran free cities as an example of competitive governance. Just as competition and free entry and exit in markets create wealth and consumer satisfaction, they believed, so would governments work better if new entrants arose to compete over rules with existing sovereigns. The rules that allow citizens to thrive—which to the libertarian-minded meant lower taxes, less regulation, and free movement of people and capital—would provide a competitive example for other states to emulate.
Among the most prominent advocates of competitive governance was Patri Friedman, grandson of Nobel Prize–winning economist and libertarian intellectual giant Milton Friedman. Patri first promoted the concept in the context of the Seasteading Institute, which he founded in 2009 with the financial support of Peter Thiel, the billionaire co-founder of Paypal, who loves financing seemingly outrageous ideas on the cutting edge of physical and political science. Seasteading advocated a free city model based not on land ceded by an existing sovereign but on land freshly built, floating in international waters.
In April 2011 the Seasteading Institute co-sponsored, along with Giancarlo Ibarguen of the libertarian-leaning Guatemalan University Francisco Marroquin, a Future Cities Conference that spun off into a Ibarguen-run think tank dedicated to promoting the free cities model. One of the conference speakers was Michael Strong, who had helped promote "conscious capitalism" with the organization Flow, launched with Whole Foods founder John Mackey.
After meeting the Honduran free cities team run by Sanchez, and after some initial collaborative meetings with one another, Friedman and Strong each launched his own company seeking partnership with the Hondurans. Friedman's was called Future Cities Development (FCD); Strong's, co-founded with Kevin Lyons, an entrepreneur and co-founder of Consent Unlimited (a nonprofit studying how to "expand the sphere of human consent at the expense of politics"), was called the MGK Group.
The idea seemed as close to actuation as it had ever been. But conflicts both within and without Honduras soon derailed the project.
'Don't Send Academics out in the Wild'
Paul Romer proved very useful in attracting international press attention from the likes of The Economist and The New York Times. But in September 2012 he left the project in a public huff after the Honduran government announced that it had signed a memorandum of understanding with the MGK Group to manage and operate an SDR. In a letter to President Lobo that he posted on the Charter Cities blog, Romer complained that the Hondurans not only failed to discuss the deal with him beforehand but also refused to let him review the agreement after the fact. As head of the Transparency Commission that was supposed to have executive power over SDRs, Romer believed the lack of consultation represented a breach of trust. In an October interview with The Economist, he condemned the MGK deal as an "overt act of deception." MGK was "not really very serious," he told the Canadian National Post in December. "They are kind of a nuisance and a distraction."
According to everyone else involved, Romer actually was not head of the Transparency Commission, which did not yet exist. Romer said Lobo told him he had been appointed and even signed something to that effect in front of him but for whatever reason never formalized the appointment.
Others close to the project think Romer assumed his starring role was in the bag and in talking to reporters tried to make it a fait accompli by acting as if it were already true. Among other things, many involved in the RED zone project found it suspicious that Romer frequently pointed to the website red.hn to buttress the claim that he was running the Transparency Commission. While red.hn appeared to be an official Honduran page, the site was launched in August 2011, registered in California, and has since disappeared from the Internet. Sanchez acknowledges that Romer "had been promised he would be part of that" but claims the "right political moment" to officially launch the Transparency Commission had not arrived. "I believe in essence he just got tired of waiting," Sanchez says. Romer provided this comment on the controversy via email: "When the auditors resign from an account saying that they can't vouch for the honesty of a firm's financial statements, and the firm replies by saying that technically the auditors have no basis for commenting because the firm never notarized the engagement letter that it signed with the auditors, everyone knows what conclusion to draw."
Romer's departure was just the beginning of the Honduran free cities' bad press. Toward the end of 2012, in response to a challenge by lawyers opposed to the idea, first the Honduran Supreme Court's constitutional chamber, a subbody of the court, and later the full court declared that the SDR-enabling constitutional amendments went beyond the Honduran Congress's authority, because "transferring national territory" was "expressly prohibited in the constitution." One analyst close to the Honduran government thinks Romer's public condemnation of the deal with MGK emboldened the Supreme Court to kill the plan.
Right after the Supreme Court decision, Patri Friedman's Future Cities Development announced it was folding after spending about $500,000 of investors' money. "The early political momentum for the RED program faltered, and the program's implementation suffered a number of setbacks and delays over the last year," read a statement on FCD's website. "As a result, we no longer see any imminent development prospects in Honduras. Since our funding was contingent on making substantial progress within a year, we are winding down the company and returning our remaining funds to our investors."
Sources in the free cities movement say FCD was already on the verge of shutting down before the Supreme Court decision. The group felt Honduran officials were dragging their feet on decisions such as choosing the site for the city, leaving potential investors unconvinced about the Honduran government's reliability as a partner.
Most sources close to the project think the successful constitutional challenge was more a result of domestic politics and left-leaning anti-globalism than a reflection of widespread Honduran concern. Historian Dylan Evans, author of a forthcoming book on free cities, says he found in Honduras that "left-wing romantic ideology is immensely powerful in Latin America still today" and that "the default is to suspect any foreign involvement of being inherently rapacious and exploitative and ruthless capitalist, so unfortunately some of the people who might be best served by alternative legal arrangements are ironically most opposed to those things."
One public relations professional who worked with a free cities company says that when she reached out to everyday Hondurans with presentations about the project, they would sometimes ask point blank: Why are you even talking to us? They knew the free cities either would or would not happen with or without citizens' input.
"It's really just a discussion among elites trying to bring it down," Sanchez says. "But as a topic, it's too technical, you know?" Public opinion won't be settled, Sanchez says, "until people see brick and mortar being placed."
The international development community, including such major players as the World Bank, the World Trade Organization, and the Bill & Melinda Gates Foundation, has not yet thrown its weight behind free cities. The Gates Foundation asked the libertarian economist Bryan Caplan to write an essay questioning its decision to not fund charter city research. Caplan, an economist at George Mason University, wrote that "there is virtually no downside" in supporting the idea. "A charter city begins on empty land," he said. "It can only grow by voluntary migration of workers and investors. If no one chooses to relocate, they're no worse off than they would have been if the charter city had never existed."
Giancarlo Ibarguen of the Free Cities Institute thinks it could be a good thing that international development organizations and non-governmental organizations don't have their hands in the free cities movement, "because they usually bring to developing countries a brilliant idea that ends up being more mercantilism and interventionism.…One of the things I like very much about what is happening in Honduras is it is really made in Honduras."
Keeping the Tanks Away
Much of the media and academic chatter about free cities concentrates on the high-level economic development issues—tariffs, taxes, building regulations, the provision of services such as roads, electricity, and water. But in talks with the principals, a possibly more important consideration rises to prominence: basic public safety in a dangerous country.
"The security issue is huge," Strong says. "If an American manager in Honduras must go from a gated community in an armored car to a gated factory, [then] a region in which normal life is possible, where you can walk on the streets, will be incredibly appealing. They do care about their workers, and a region in which workers and their families are not subject to random violence is appealing."
Strong envisions the ideal free city as not just an industrial park but a full community, with schools, hospitals, welfare infrastructure, and security. But he believes those services can be supplied at lower cost and with more responsiveness to consumers than what a typical government offers. The publicist who was trying to sell the idea to grassroots Hondurans also found security to be a keen area of interest. If free cities were noticeably safer, they might attract domestic migrants.
Political safety is also a key concern, particularly for potential business operators. Shanker Singham of the International Roundtable for Trade and Competition, who is working with Strong, says, "If the investor community believes the host government can interfere in the same way they interfere in the rest of the country, obviously the investment proposition is the same as the rest of the country, and they simply won't invest. In that case we have to make investors not so concerned about the nuclear option, about tanks rolling in."
Behind the anxiety is an unanswered question: How would the government, and the people it represents, react to a Hong Kong–style economic miracle within an otherwise miserable country? How would they react to allegations from people who, in Singham's words, are "terrified" that outside capitalists are "simply using their country to achieve some foreign investor's profit"? With everything relying on the ceding sovereign keeping its word, it's hard to know whether a successful free city would be able to survive for very long.
Singham thinks the uphill battle to win hearts and minds is worth it. "We see [SDRs] as a means to an end, and the end is poverty alleviation," he says. "When you deviate from the free market and pro-competitive regulatory system, you are imposing deadweight losses on the economy and imposing a regressive tax on poor people. And that's unconscionable and immoral, and that needs to be expressed clearly."
Free Cities: The Sequel
After the dissolution of Future Cities Development and the Supreme Court defeat, the dream of Honduran free zones seemed destined to join the sad but beautiful pile of bones of libertarian polities dating back to the early 1970s attempt to build a libertarian island near Tonga. (That sandbar was conquered by the King of Tonga in 1972.)
A similar free-cities rise and fall story has also played out in the former Soviet republic of Georgia. Klugmann and Romer both met in 2011–12 with Georgian President Mikheil Saakashvili, who became very excited about the idea of building a free city he had already named Lazika. But with a change of regime late last year, the Georgian free zone idea is currently dormant. Other free city initiatives have made initial entrees into Senegal, Jamaica, Morocco, and Guatemala, although none have yet borne fruit.
But Honduras still might. In January a second round of constitutional amendments to legalize free zones passed through Congress the requisite two times. Still ahead: the more complicated task of the new statute laying out the leeway those zones will have and the rules by which they will interface with Honduras proper. Elements of the Honduran judiciary and potential RED zone operators are both being kept in the loop as stakeholders of sorts, which makes sense. As someone close to the negotiations put it: If one intends to throw a party, it's best to make sure that the cops aren't going to shut it down and that people are still going to want to attend.
It's uncertain whether the new law will emulate the rules set the first time around, although Sanchez says that is his goal. The new enabling law for the zones was expected to get through Congress in May, although non-Hondurans close to the project note that things often grind slowly in that nation. Whatever happens, there should be plenty of varieties available to those wishing to launch an SDR.
"The Honduran government wants to create as many of these as possible," Strong says. "Their vision is of islands of prosperity in multiple locations, so [competing to get to operate one] is not a zero-sum game."
Strong has left the MGK Group, whose website says it has "suspended operations." He has launched a new organization, Elevator, which will compete to manage and run a Honduran SDR, paying off investors with money made after his group "purchases undeveloped land (or receives government land) and adds both physical infrastructure as well as world-class law, governance, and security," he says. "Successful free zones around the world have seen significant land value gains following free zone designation, which typically consists of reduced taxes and regulation. We believe that having access to better-than-Hong Kong-quality legal institutions will increase land values to an even greater extent."
Sanchez says he isn't worried that the latest attempt will again be derailed by the Supreme Court, because the original opinion was legally flawed, and four members of the constitutional chamber that first overturned the law "were removed from office by Congress because of gross ignorance." Non-Hondurans involved in the process think the Supreme Court decision was more a matter of internal politics and an expression of opposition to the president of Congress, the free cities supporter Juan Orlando Hernandez, who was (and still is) running for president. While another legal challenge is possible, even likely, Sanchez and others involved say the new law will be carefully crafted to be as bulletproof as possible.
Mark Klugmann, who has been working to sell free cities (LEAP zones, in his preferred terminology) to Honduras for more than a decade, says he is not discouraged by last year's setbacks. "If the defeat in the Supreme Court last October caused some to think that the reform path of creating special LEAP jurisdictions is not politically viable, that it collides with reality…the truth is exactly opposite," he says.
"What Honduras demonstrates," Klugmann maintains, "is how robust this idea is—that it is hard to kill. Before the ink had dried on the reform's obituaries, the Honduran leadership was back up on the horse, did it again, and once again, as two years earlier, won overwhelming congressional support: 90 percent of the legislature voting in favor, transcending the divisions of left and right, erasing the gulf between government and opposition. Honduras has taken the lead in disrupting the status quo.…Now the neighboring CAFTA countries, all competing for investment and jobs, must come to grips with the prospect of a game-changing challenge in their region. For those who care to see, what becomes clearer than ever is that this is a very powerful idea whose time has come."
