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  • noahchonlee

Why Should We Care About Charter Cities and Special Economic Zones?

Updated: Apr 2

TL;DR Governments are generally monopolies without any competition incentivizing them to improve. Special economic zones and charter cities can be to countries what startups are to big corporations. They can innovate and cause the industry to adapt (in this case, the industry is governance/law) by demonstrating better policies.


Beheadings and an Orphanage

I am writing this article from a (blissfully) airconditioned Quiznos in El Salvador. I traveled here to meet a friend who is attempting to travel from South America to the USA to find better work opportunities. He has been making $15 a day working in construction.


I have joined him for one of these jobs constructing a bathroom and I can confirm it is hard labor. One month, the company simply decided to simply not pay him for all the work he did. Meanwhile, in many places in the USA people are making $15/hr minimum.


It is his dream to start an orphanage because he also grew up without family to take care of him until finding an adopted family and he wants to provide other kids with a safe home and educational opportunities because he understands what it is like to not have a caring family and stable opportunities. Looking into making this, the legal difficulties of setting this up are a significant hurdle. He looked into starting his own transportation business, but it would have been difficult to obtain the necessary operating licenses. So he thought he needed to leave his family and travel to the USA to work and save up in order to return and make this vision a reality. He was preparing to walk across the jungle of Panama, but I bought him a flight and met him here. Now we are here watching videos of cartels beheading immigrants like him who are trying to reach the USA. He still wants to try. I know that at best his adopted toddler daughter will have years without her father and at worst she loses him forever. He shouldn't need to take such drastic action. He should be able to establish a good life for himself and his family and pursue his dream. Why do so many people need to leave their entire continent to find better opportunities?


The Tale of Magatte Wade

I highly recommend watching this talk by Magatte Wade where she says it better than I can:



If you did not watch the video, here's a recap: Growing up in Senegal, Magatte would hear about neighbors and friends drowning as they tried to take boats to Europe. She was in Whatsapp groups where they tried to buy back the freedom of people who were captured and enslaved in Libya on their way trying to reach Europe. It costs a few hundred dollars to buy the life of a slave there. The people who did make it to Europe oftentimes transformed a life of intense struggle into something far more plentiful. She wondered, how come the same person could actualize on that continent and not here? This question shaped her pursuit until she finally became convinced of an answer: bad regulation means it is hard to start and run a business which means it is hard to make new jobs and create wealth. For example, the regulations in Senegal make it extremely difficult to fire someone, which actually results in companies being far more reluctant to hire anyone.


With this belief that we need better governance, Magatte began the Centre for African Prosperity in partnership with Atlas Network to promote economic freedom and strong institutions including through looking at charter cities and special economic zones. I was grateful for her joining as a speaker at the Startup Societies and Crypto Cities Summit I was helping organize in Próspera charter city in Honduras. Próspera is built using the ZEDE special economic zone framework enshrined in the constitution of Honduras. This charter city has wide reaching sovereignty over corporate law (though not criminal law). This means that they have the legal authority meaning that they have the legal authority to implement ideas worth billions such as a tokenized asset registry as described in my post here: https://www.noahchonlee.com/post/how-to-create-a-tokenized-asset-registry-in-a-special-economic-zone

Another city using the ZEDE framework is Morazán next door to San Pedro Sula which is known as the "murder capital of the world." In this incredibly dangerous area, Morazán has established an area where it is easy to build up a business, live in safety, and pay rent with less than $100 a month.


What is a Special Economic Zone and What is a Charter City?

A special economic zone/SEZ (also called a special administrative region, free zone, etc) is basically a jurisdiction in a country which has different regulations. There are physically delineated SEZs and there are also digital SEZs (generally called digital free zones.)


There are several thousand SEZs worldwide of which 1000 were established within the last five years. They are often used to spur certain industries by offering tax benefits. However, there is a rising wave of holistic special economic zones with wider reaching autonomy to determine their own corporate law. These are oftentimes paired with a charter city.


A charter city is a city that has its own charter that it follows as its guiding governance document. You can think of the SEZ as the legal layer and charter cities as a physical layer that may be built on top of the regulatory framework of an SEZ. Multiple charter cities might be built using the same SEZ as their legal foundation. In essence, the SEZ grants a group more freedom to dictate their own governance.


Shoutout to Joyce Dinglasan for helping me create this visual

For the total governance stack:

Lvl 0: The host country, its constitution, are the basis Lvl 1: The legal framework of a special economic zones (generally inheriting the same criminal law as the host country) Lvl 2: The physical infrastructure and laws of charter cities Lvl 3: Communities, businesses, and foundations that grow in the charter cities


Lack of Competition Holds Back Progress

Sometimes laws with good intentions fail to take into account reality. For example, my friend's teenage sons tried to sell cookies in Ecuador but were stopped by the police because of child labor laws. Instead of being able to gain experience running their own enterprise and contribute to the family, the result of the law is that they cannot even set up a lemonade stand. Clearly, it is possible to make better laws.


So why are governments so hard to improve? The complex answer ranges from voting systems that result in polarization such as in the USA, colonial powers setting up unreasonable borders, foreign powers fighting proxy conflicts through local factions in order to gain geopolitical control and access to resources, and much more. But at the most fundamental level, it simply makes sense in the current world that many governments do not have the right incentives to improve because they are oftentimes monopolies. Someone's citizenship is generally assigned by birth rather than consent and it is difficult for most people to change which government's control they are forced into. If your consumers (in this case, taxpayers) are trapped, then there is no reason to improve services.


Why Would Charter Cities Be Better?

It’s not a matter of pride to say a different group will be better at managing a government. It’s simply the inherent nature of scale: smaller groups can move faster. A startup may pivot faster than a massive corporation. A charter city may adapt to find better regulations faster than its host nation, and then the entire host nation may benefit from those discoveries. Charter cities may also adapt to local needs far better simply because they are not managing as large a behemoth. 


Each special economic zone and charter city offers an opportunity to run experiments, to have competition, and to find what policies result in the best outcomes. 


What if instead of two polarized political parties shouting at each other about what they think should happen, we had two charter cities which each followed the policy of one of the parties and we studied the results and decided which policies to implement on a nation-wide scale based on this evidence?


How I Discovered SEZs and Charter Cities

My first time ever using crypto was when it was the only way I could find to pay my friend Mohammed for work he did for me as my virtual assistant. As we became friends, I discovered that it is difficult for many Syrians under the Turkish administration to obtain work permits.


In other words, people are in a position where they are already in a location without the administration allowing them to work in that location. This sounded absolutely insane to me. The host country is forcing residents into being a drain on society and missing out on the ways they could be contributing to the economy while building better lives for their families. On the other hand, my friend from Ecuador thinks that the influx of Venezuelan refugees into the labor market is part of why he is paid so little for his construction work.


I started to imagine a world in which Turkey established an “experiment state” as a micro version of the nation/a city state that Syrians could choose to join and in doing so consent to participate in different cycles where various policies are implemented. I wrote up a story outline where this begins poorly and somewhat Hunger Games-ish as desperate people are taken advantage of, but over time the experiment state becomes successful because it is faster to implement new ideas and to validate/invalidate them. Then I discovered that this concept exists in real life and they are called special economic zones, but we are barely beginning to harness the true potential for these innovations.


Will Incumbent Governments Be Open to This?

But of course, nations will be scared of taking this risk, won’t they? What if this becomes a tool for separatist groups or a ploy by local elites or foreign powers to steal sovereignty? I would say that these are real risks that should be taken seriously. In light of that, who would try this? Turns out, China already did. 


The famous example is Shenzhen. When this tiny fishing village was designated a special administrative region (the Chinese version of “special economic zone”) it grew from a tiny fishing village into one of the most advanced cities in the world within a generation. As the administration witnessed this radical transformation thanks to this policy change, the entire nation followed suit by implementing certain free-market dynamics, which led to the greatest economic boom in history, lifting hundreds of millions of people out of poverty. I think this is barely scratching the surface of what special economic zones and charter cities may accomplish. 

The "Race to the Bottom" Concern

How many friends of yours move to a new cell phone or insurance provider in order to find better service? With charter cities, we can do that with governments. We already see this among states in the USA. Some move to California because they appreciate the welfare and businesses, whereas others choose to leave because they think the state of the bureaucracy is not worth the taxation.  One concern here is the “race to the bottom,” in which everyone moves to the jurisdiction which offers the lowest tax rate. However, if that jurisdiction lacks funds to build worthwhile infrastructure and make a decent area that people want to move to, then people will not move there. As can be seen by Norway still having a population despite being in the EU and thus making it easy for residents to move elsewhere, people are willing to live there and pay higher taxes in order to receive better service.


In other words, most people don't really "race to the bottom" in terms of physically moving. Instead, they will put in immense efforts to be wherever the best governance exists.


However, the "race to the bottom" is an issue in terms of the movement of legal and digital assets. The rich oftentimes live in a high tax country while moving their assets to a lower tax jurisdiction for example by living in Switzerland while their assets are "technically" based in Montenegro. This makes them the biggest free riders who benefit from a country without contributing their fair share. For physical assets, charter cities might help resolve this prevalent issue by experimenting with land value and Harberger tax systems. Such systems may prevent costs of rent, vehicles, and infrastructure from inflating as the wealthy buy them up as stores of value rather than utliizing their full potential.


Why Charter Cities May Be Inevitable

In terms of digital assets which don't really have a clear physical location, I cannot currently think of any solutions to this issue. Even a "wealth tax" is extremely difficult to enforce because of how easy it is to hide assets. In fact, I think this is the reason why charter cities are becoming increasingly inevitable: As ZK cryptography, Monero, and other technologies make untraceable financial systems a reality, it will only become more difficult for governments to collect taxes by force. As privacy technologies improve, governments will increasingly need to convince people to want to pay taxes. Governments will need to realize that governance is a service in a marketplace where people have options on what to subscribe to. The countries which make this perspective shift successfully will fare the best in the coming decades, and charter cities may be the perfect tool for this because they allow a nation to encourage demand-driven experiments innovating on ways to make a jurisdiction and governance system appealing.

The "Brain Drain" Concern

There is also the issue of "brain drain" in which the wealthiest, most educated, and most skilled workers leave a country to find lives they prefer. Charter cities may help address this issue by offering a way for citizens to choose between governance systems they prefer without leaving the nation. In other words, the only successful way to combat brain drain (other than making your country into a prison such as Eritrea or North Korea) is by making it so that people want to stay through innovating in governance.


Both the USA and the EU are the wealthiest areas in the world in part due to their confederated system of jurisdictions within which there is easy migration.

With Brexit, England left this system. Whether good or bad, perhaps England might still benefit from a system of being able to choose their desired jurisdiction. By adopting charter cities, any nation might harness the power of giving citizens choice in a way that makes the nation a global leader in the future of governance. Charter cities are not a replacement for international unions, but it certainly shows that even a single country has the ability to adopt the benefits of jurisdictional choice. If international negotiations to form an east African union stall, a single country such as Tanzania need not wait to encourage greater industry and trade through creating trade zones and by encouraging charter cities to emerge with their unique specializations and generalizable innovations.

The USA is an example of an intra-national system of governance innovation through multiple jurisdictions co-existing within a single country. In the history of the USA the founding fathers received inspiration for the system of states from the Haudenosaunee confederation. Since then, that system became the most successful the world had ever seen. However, it certainly has its issues and could be improved upon. What if we moved a step beyond that and decentralized further? 


The "Balkanization" Concern

There is an important distinction between "decentralizing" and "balkanizing" into multiple countries.


Balkanizing has its issues. One reason why so many investors prefer businesses in the USA compared to the EU is because the different regulations in the various countries in the EU makes it complicated to expand into the entire market. In other words, there are ways that a proliferation of different governance systems may make it harder to conduct business across a larger market due to "local maximas" taking root that do not make sense on a larger scale. A country considering implementing charter cities ought to consider what sorts of undergirding business practices should be enforced on a national scale to prevent this outcome.


Even without fully separating into different countries, certain jurisdictions within a nation might take advantage of the collective. For example, a free zone in a port might charge a high tariff that increases the cost of imports at the expense of all the other jurisdictions. Such instances show that there may be times when a federal entity or a council of representatives in a confederation needs to step in to enforce their authority in order to protect the collective. There is a spectrum of possible balances between central oversight and local governance. It also shows that a nation should be thoughtful in what sort of sovereignty it grants in terms of taxation.


As with any important change, there are risks to SEZs and charter cities to consider. However, consider the future that they open.


I think SEZs may lead to a global future in which there are dynamic borders, peaceful market competition amongst governments, and a historic revolution in the evolutionary process of governance. 


Imagine if there were dozens of charter cities in your country. Perhaps it is difficult to start a business in the city where you are because the bureaucratic process and paperwork is mind-numbingly slow. If you could take a bus to a neighboring town where they built a far more efficient system, wouldn’t you go there? And as more people move there, perhaps the charter city may buy more land and expand and the one you left needs to sell properties as more people leave. In this way, people “vote with their feet” and the capacity of certain governance systems expand or contract according to demand. This offers a way for people to peacefully and economically state their preferences for governance rather than resorting to violence. After all, if peaceful revolution is made impossible then violent revolution is made inevitable.


Nation-states may grow more successful by adopting the best practices and by allowing the local groups to morph and grow and shrink according to demand. What if this could lead to greater peace in places like the Balkans, Sudan, and other areas where ethnic conflicts are tearing people apart? Perhaps there is a better answer than Balkanization in order for a nation to improve its governance and take into account differing preferences and demographic divides within itself. What if welcoming the rise of charter cities would help establish peace?


Conclusion

We need to create systems that open the door to innovation in governance.


The reason I care about special economic zones and charter cities is because my friend’s daughter should not have to grow up without a father because he thinks he needs to walk to another continent to begin his own business and nonprofit. Next, I intend to write up an overview of charter city projects I am bullish on and then some in depth dives into them.

For a map of special economic zones see:

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