The Blank Slate State

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.”