Honduran 'Free Cities' Get One Step Closer to Reality

Will they provide legal innovation, or merely business-friendly regulation?

Back in January, the new administration of Honduran President Juan Orlando Hernandez was hyping the possibility of what were now officially called Zones for Economic Development and Employment, or ZEDEs. The concept has been known by many names: charter cities, LEAP (for "Legal, Economic, Administrative, Political") zones, free cities, and startup cities. The general idea is creating zones within a country that can experiment with different economic, regulatory, and legal systems than the rest of the country—with the hope that these innovations might lead that sector to prosper more than the country at large.

Honduras is—again—a step closer to creating such zones. As interviews in July with many people involved in the process or watching it eagerly for signs of real progress showed, it's still many steps away from them becoming real. (I wrote a feature for Reason's June 2013 issue on the first rise, fall, and rise of the ZEDE concept in Honduras.)

The need for some kind of extreme change in Honduran circumstances remains acute. Although President Juan Orlando Hernandez has been bragging that the murder rate in the first half of 2014 was lower than in the same period of 2013, Honduras is still a mess, still a major source of refugee children risking all to get to America, and as of this week is still earning huge New York Times features painting a horrific portrait of a land where nothing works, everyone is in peril, and everyone wants to leave. It's an anti-wonderland of lawless misery, where remittances from Hondurans who made it to the U.S. account for 20 percent of the entire national economy.

As one observer of the ZEDE scene told me, it's not surprising that the kind of radical, perhaps even desperate, experimentation that ZEDEs represent would get the most traction not in some place like Switzerland or Sweden, but a place exactly as troubled as Honduras, as a sort of Hail Mary pass to create some legal safety and economic sanity.

Honduras might be getting there, however slowly. In May, the Honduran Supreme Court's Constitutional Chamber gave the newest enabling legislation for the zones a thumbs up. The legal challenge against ZEDEs was joined by over 50 non-governmental organizations—the sort of national and international do-gooders that tend not to love the idea of more unrestricted free markets as a development solution—who framed their position as being against dreaded "foreign investors" winning control over parts of Honduras.

In February, the government had already appointed members of the Committee for the Adoption of Best Practices, which will be responsible for setting forth specific details of the standards that entities wanting to operate a ZEDE must follow, and to appoint (and remove if they wish) the technical secretaries (who must be Honduran) managing specific existing ZEDEs. The Committee is also charged with hiring respected outside auditors for ZEDEs and assorted other managerial and inspecting duties for them. The group of 21 was specially selected for an understanding and appreciation of free markets. It includes free-market movement types like Alejandro Chafuen of the Atlas Network, Mark Skousen (who used to run the Foundation for Economic Education and runs the yearly "FreedomFest" in Las Vegas), and conservative movement organizer Grover Norquist.

Norquist thinks that being too shockingly innovative in law or vaunting about its world-changing promise might not be the best way to launch the ZEDE concept. "You really want this to be understated, not overstated; underpromised, not overpromised. If you say we're gonna change the world and create a million jobs, if that doesn't happen in the first three months people will say, 'ah, it didn't work!' You want everyone else to see it works so they say, 'why not have two?' instead of 'hey what's that? Hope it doesn't spread!'"

The latest enabling legislation has many promising characteristics for those seeking political and market innovation. ZEDEs, it declares, are under normal Honduran law when it comes to "sovereignty, application of justice, territory, national defense, foreign relations, electoral topics, emission of identity documents and Passports." But otherwise they shall be able to adopt other existing legal systems that guarantee best practices (though some watchers fear that Honduran pride will be damaged if legal systems flying wholesale under other flags are "imposed" on ZEDEs and instead advocate freshly developed legal systems rather than, say, Texas' or the U.K.'s). ZEDEs can run their own courts, form their own customs (though they "must operate on a policy of free trade and competition"), and have their own tax regime (where individual income tax rates cannot exceed 12 percent and corporate income taxes cannot exceed 16 percent).

However, except for special exceptions, "It is prohibited to employ less than a ninety percent (90%) of Honduran workers and pay them less than eighty-five percent (85%) of the total wages earned in their respective companies." Existing high-population areas can only become ZEDEs through plebiscite.

While nothing is set in stone yet—and various non-Hondurans who have been involved in the process assure me that one should assume every announced deadline will end up being punted—recent interviews with some folks involved in the ZEDE process indicate two paths seem most likely to come to fruition quickest.

One is a shift of an existing maquiladora program in Honduras toward a more explicit ZEDE model, which was explained to me by Guillermo Pena Panting, who runs a Honduran classical liberal think tank called the Eleuthera Foundation. Pena tells me he is working on a "pragmatic, non-ideological" project to get the business interests behind existing maquiladoras to experiment, and show the world the benefits of forming a ZEDE, even above those of existing maquiladoras, which have become stagnant lately in their job-creating ability.

Pena is satisfied that the second round of legislative and court approval of the ZEDE concept means it will have a healthy future in Honduras, even though many in the existing private and business sector might be skeptical. "The way the economy has worked here has been more an influence economy than a knowledge or merit economy," he says, which leaves ZEDEs in some ways a threat to existing interests.

Pena is confident the government will do all it can to make ZEDEs work, to improve the country's negative image, and "to finally get rid of Honduras in media and international opinion ending any story by saying it's the 'murder capital of the world.'" Pena also fingers Honduran complications in contract compliance and labor regulations as things that ZEDEs will help fix. "To be a friendly country to investors doesn't only mean treating their money well, but treating them well" and so ZEDEs would best adopt immigration polices easy for "entrepreneurs and professional so companies can bring the best people in for their projects" (within the labor-protectionist 90 percent Honduran rule).

The Honduran government itself is in negotiations with the South Korean government agency KOICA about moving forward on a possible ZEDE, says Octavio Sanchez, leading Honduran advocate of the ZEDE process for many years and a member of the Committee for the Adoption of Best Practices. The PanAm Press reports that a feasibility study from Korean infrastructure company Posco Plantec is reportedly in the works now, though Sanchez says that isn't true.

As reported in the PanAm Post in February, Honduran Cabinet Secretary Ebal Díaz said that "after the study, we will proceed to create a master plan, with a detailed design, that will take into account all the environmental, population, and governance variables, as well as economic trade zone and cooperation considerations with the various companies that have participated in this joint effort—to promote investment in the south of the country." Some speculate that the Gulf of Fonseca might become the site of a ZEDE that crosses into neighbors El Salvador and Nicaragua, both of whom are watching the Honduran experiment and discussing their own variant on same.

Some ZEDE watchers worry that leaning toward existing maquiladoras and Korean government sponsorship means that the potential for true legal innovation may get squeezed out of the process, and tell me that one ought not underestimate the sclerosis and corruption of existing Honduran politics that even the ZEDE process may not be able to overcome.

But Mark Klugmann, the American who introduced the ZEDE concept to Honduras via Sanchez (though his original preferred term was "LEAP zone") is more confident that Honduras won't blow this chance. "There is nothing Honduras can deliver on tax incentives or financial incentives that rival what it can do with the rule of law," he said. He points out that the World Trade Organization frowns on what it sees as governments providing unfair subsidies to its domestic industries. But, he points out, "rule of law is not considered a subsidy; property rights are not considered a subsidy; judicial independence and transparency are not considered a subsidy; security so you don't get murdered or kidnapped is not considered a subsidy. And these things routinely provided in developed countries are actually a scare resource in poor countries." ZEDEs will only work, and Klugmann thinks the Hondurans want them to work, if they are "not about leveraging poverty" alone, "but about providing rule of law."