Here’s a common objection to the logic behind the proposal for building charter cities in poor host countries:
If investment in urban infrastructure can really generate win-win benefits for investors and residents of poor countries, why isn’t it happening already?
To see why, start by picturing a familiar long-term investment. Imagine that a lender (an insurance company perhaps) wanted to do a long-term deal with a borrower (someone who takes out a 30 year mortgage to build and live in a home.) If all the borrower can do is make a personal promise, the loan will never take place. Even if the borrower is very concerned about her reputation and always sticks to her word, the lender might reasonably worry about being repaid. If the borrower dies, for example, she can’t be sure that her heirs will stick to her promise.
The leaders in many poor countries face the same problem. They can’t control what future political leaders will do in 5, 10, 20 or 30 years. No one knows if future leaders will enforce the terms of any agreement entered into in good faith today. Residents want to pay for infrastructure. Investors want to earn a return by supplying it. Leaders want the deal to be done. Nevertheless, the investment does not take place.
In a country like the United States, mortgage lending can take place because borrowers and lenders can rely on a neutral third party, the court system, to enforce the terms of an agreement for decades into the future. A partner country can do for a country with excessive political risk what the court system does for the United States. They can act as a third party guarantor of an agreement between investors and residents.
The risk that a future government will breach the terms of an agreement is called political risk. An investment in a piece of infrastructure such as a power plant or an airport requires a large initial outlay and pays returns for decades. An investor who contemplates an infrastructure investment in a country with political risk has to take account of the chance that after the initial outlay, the local government will deprive it of a chance to earn the return. An investor who might be willing to accept a 10% rate of return in a country with no political risk might require a 20% or 30% rate of return to invest in a country with an unpredictable legal and political system. Some investments, oil wells for example, can generate this kind of return, but rates this high kill most infrastructure projects.
Political risk is like the worst kind of tax. It stifles valuable economic activity without raising any revenue for the government. By providing administrative oversight in a charter city, a partner country can help a host country remove this tax.
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This is reasonable as far as it goes, but I think you need to go a little further with the explanation of exactly how involving a partner country reduces political risk.
On the one hand your charter city scenario seems to assume leaders who are restricted in their scope of action by the possibility of popular discontent (e.g., your example of resistance to increases in the price of electricity in your TED talk). That’s why (according to you) starting with a clean slate is the best option. On the other hand the leaders have to have enough power that they can basically force through creation of a new city from scratch.
So what happens if there’s a future leader who wishes to reverse this, has the authoritarian power of his predecessor, and is backed by popular anger at the “foreigners” who’ve been given the task of running the charter city. What’s to stop him?
One answer is presumably some fear of provoking an international dispute possibly escalating to war. Is this the whole answer, or are there other factors at work? If this is the whole answer, what must be the case for the fear of the likely consequences to be high enough to deter a leader pre-disposed to stir up trouble and backed by his people? (For example, does the partner country actually have to exercise sovereignty — sole or joint — over the charter city?) There has to be the equivalent of a “poison pill” provision in order to deter a hostile takeover; what does that look like?
— Frank Hecker · Aug 12, 08:35 PM · #
Political risks might actually be worse to me in city-states. I’ve seen reason to believe city-states are less stable. Liechteinstein chose to dedemocratize more toward a monarchy. Classical Athens, one of the most successful city-states ever,
still suffered changes of gummint type. The Florence that produced Leonardo da Vinci had political street violence, was famously unstable, and elected the infamous Savonarola.
Wouldn’t charter cities also be vulnerable to added security and corruption risks? Aren’t city-states likely to munched by bigger neighboring states and raided, especially if they’re successful? In your Cuba example, I’m tending to think you’d also have the same horrid corruption problem from the Canadian officials as old-fashioned colonies did unless they could be as easily prosecuted or impeached as at home.
What kind of security guarantees would you expect from the states involved, and why would host states make those agreements, given the realities of imperialism’s nasty past?
— Jon · Aug 13, 01:28 AM · #
Overall it makes sense. The key then is for the host country to follow the agreement, like China did about Hong Kong. That trust must be a minimum condition for the initiative to happen, which means the host country needs a minimum level of political predictability.
— hyokon · Aug 13, 09:06 PM · #
Er, hyokon, what CHOICE did China have about what happened to Hong Kong? How many pounds sterling in drugs went through HK entirely against China’s will to found HK’s fortunes? Didn’t that even cause political instability in the form of the Boxer Rebellion? But the Western Powers put it down, so no problem there? And, in the 20thC, HK profited from China’s woes and instability because it was held against the Chinese will but was guaranteed militarily stable by the UK.
Charter Cities’ rises will have to follow different profiles than HK’s, since enforcing the drug trade isn’t an option anymore.
— Jon · Aug 14, 09:36 AM · #
Jon,
my understanding of the Boxer rebellion is that it was a reaction against Christian missionaries: it started in the north of China and culminated in Beijin. Hong Kong is far south of all that.
another thing is that HK has always been extremely convenient for China, many of the ruling communist families of China kept their wealth safe in Hong Kong, this is a well-known pattern which explains the existence of places like Monaco, Liechtenstein, and so on.
China could have taken Hong Kong back several years after the second world war, since the 1960s at least, but chose not to — there’s a famous incident where the impoverished Portuguese government begged China to take Macau back, but they declined, as they were too busy with their cultural revolution.
— pat toche · Aug 14, 10:34 PM · #
Whoops – I had a memoryo – I meant the Opium Wars, of course.
How would you feel if the US HAD to let the drug trade operate freely and without restriction, and had no option but to let drug growers operate freely as well, or see technogically superior military response and occupation? Would that be hunky dory with you?
Oh, yes, China could’ve just asked that nice pro-imperial Churchy nicely and he would’ve agreed to turn over one of his nicer cities. And, you don’t see Romer giving Macau as an example to hope after, do you, and Portugal’s economy was much weaker.
— Jon · Aug 15, 11:52 PM · #
why of course, the opium wars, absolutely, the history of the creation of Hong Kong is, roughly speaking, that the Chinese were offended by the Brits who wanted to trade opium more freely in Canton/Guanzhou, but were allowed in only several months a year and without the wives, the Brits broke the curfew rather rudely, so the Chinese decided to kick them out of Macao. As they went looking for them in Macau, with Portuguese assent, the Brits (and only the Brits, the other nations went on their usual opium business) fled to their ships and, surviving on rations sent from the Philippines, wandered about the seas for several months, until her Majesty decided she’d had enough and since the Portuguese were not to be trusted, she decided to settle her own little place, there was this rock occupied by illiterate fisherman, they took it in no time at all as the Chinese, then, had no navy to speak of. So it’s a story of arrogance, violence, and all that, absolutely.
In Macau’s heydays it was the great city of East Asia! Then the Portuguese empire was ruling the world’s oceans, kicking the butt of the Dutch, the Brits, the Spaniards, the Japs, everyone. I think Macau is a nice example of a charter city because force was never used to establish the trading outpost (with the exception of the opium wars, a few hundred years later, but by then all the action had moved to Hong Kong and Macau was just the backwaters): Macau was once the world capital of opium, later the main trading port for … Chinese slaves to be sold in the land of freedom that was then the Americas (north and south). E viva Macau!
P.S. These are things are remember off the top of my head, inaccuracies may lurk here or there.
— pat toche · Aug 17, 10:02 PM · #
to answer your first question, as I’m not American and feel very deeply about the CIA-financed dirty wars of Latin America in the 20th century, well my answer may not be quite what you’d expect!
But okay, let’s pretend, after all my son is American. Well, I’m of the view of Jeffrey Miron, expounded here:
http://www.youtube.com/watch?v=1Yx9dFVa19o
— pat toche · Aug 17, 10:10 PM · #
I listen to your TED “talk”, congratulations. I disagree with this article, investment is taking place, just with the old financing rules, through public spending. This is good enough for the top 50 countries in the world, but the rest of the world depends purely on the IMF and other investment banks to give away money for international companies to come in and take some profit, there is really no long term plan, since, as you refer, there is no political insurance and the risk is too much for international companies to invest.
There are a lot of tools that can be used to minimize financial risk, how to do it in a ethical way can be an issue, can a solution be for companies to lend their money to the IMF just like countries do?, this could take a lot of the risk involved and give those companies the long term project they seek, instead of going into a country to make 30% profit in one project that lasts 3 years it can make 10% profit during 20 years. Also it could increase exponencially the investment capability of IMF in poor countries to make a real diference and with that being able to go for more challanging projects.
IMF/World Bank debt relief program for the poorest countries has taken out 51 billion, this is a drop for big economic groups, imagine if coorporate goes into the world bank, lend their money at 2 or 3% rate to poor countries and still get a ROI from the investment of their money.
It needs rules, the private sector will never look at investment in infrastructure without a way to garantee its profit and it must be regulated for it to be fair and not to see 50% margins.
— Hugo Fonseca · Aug 19, 04:15 AM · #
I listened to your TED “talk”, congratulations. I disagree with this article, investment is taking place, just with the old financing rules, through public spending. This is good enough for the top 50 countries in the world, but the rest of the world depends purely on the IMF and other investment banks to give away money for international companies to come in and take some profit, there is really no long term plan, since, as you refer, there is no political insurance and the risk is too much for international companies to invest.
There are a lot of tools that can be used to minimize financial risk, how to do it in a ethical way can be an issue, can a solution be for companies to lend their money to the IMF just like countries do?, this could take a lot of the risk involved and give those companies the long term project they seek, instead of going into a country to make 30% profit in one project that lasts 3 years it can make 10% profit during 20 years. Also it could increase exponencially the investment capability of IMF in poor countries to make a real diference and with that being able to go for more challanging projects.
IMF/World Bank debt relief program for the poorest countries has taken out 51 billion, this is a drop for big economic groups, imagine if coorporate goes into the world bank, lend their money at 2 or 3% rate to poor countries and still get a ROI from the investment of their money.
It needs rules, the private sector will never look at investment in infrastructure without a way to garantee its profit and it must be regulated for it to be fair and not to see 50% margins.
— Hugo Fonseca · Aug 19, 04:16 AM · #
Zoellick, China Fund in Talks on Africa – “Zoellick said he and other World Bank officials are hopeful that Chinese companies will start investing in manufacturing in Africa as well. He said he had on this trip also talked with China’s Ministry of Commerce about potential cooperation on industrial zones in Africa.”
— glory · Sep 2, 02:27 PM · #
Political risk = government violence. Thank you Professor for identifying the #1 factor causing/prolonging human suffering for the last century. What most of you don’t get is that the Professor proposes that a government less violent towards the free market be allowed political sovereignty, a monopoly of violence, over an area with currently little economic value so the ceding government has less objection. He uses euphemisms in his talk by suggesting 1st world nations take over areas in 3rd world nation territories. Sure it may sound like neo-colonialism, but the most prosperous nations currently were colonized – hint: capitalism and rule of law were brought. The Professor I surmises uses the terms ‘ideas’ and ‘rules.’ The free market works, and capitalism is the only sustainable method to produce goods to raise the standard of living of humanity. Want to talk about the environment? He’s right- 3rd world nations’ natural resources are decimated by inefficient processes such as trees for fuel and planting corn. He’s right – who would make an investment if their property can/may easily be expropriated? Saving is sacrificing current consumption, and happiness, for the future but why save if it will be stolen? People will continue to live hand to mouth.
— ModelCitizen · Sep 2, 11:48 PM · #