Nothing characterizes the failure of development aid in a better way than the naked numbers. When the African countries became independent around 1960, Africa’s share of world trade was about 5.5 percent. Today, it’s only 5 percent and that despite the population having quadrupled. During this period, the World Bank has channeled more than $ 1 trillion in aid to Africa. The Zambian-born economist Dambisa Moyo calls western development aid “Dead Aid” and pleads for its abolition.
These facts also suggest that if Africa disappeared from the map tomorrow, the impact on the world economy would be marginal.
But given its size, population, raw materials, and fertile soils, Africa has significant untapped potential. The former German ambassador to Cameroon, Volker Seitz, has shown convincingly (most recently here) that development aid is counterproductive because it paralyzes personal initiative, creates disincentives, and works more in the interests of the “poverty industry” than the developing countries. Ultimately, too much of the money ends up in the pockets of kleptocratic politicians. Persisting on this failed policy is continuing to waste taxpayers’ money. What should be done?
Trade instead of Aid
Instead of continuing with the ‘Dead Aid’ regime, Volker Seitz proposes instead to focus on closer cooperation with the local private sector instead of betting on planned-economies-like alms distribution. While undoubtedly a commendable approach, his idea of “promoting free entrepreneurship and creating jobs through the establishment of business plans” will not succeed. A business plan is initially nothing but a plan on paper. It can be quite an ingenious plan, but if the real-world conditions do not allow for implementation, no new businesses will come into existence. And that’s exactly the problem.
I would like to describe some of the difficulties Africa-based entrepreneurs face as they attempt to start companies:
- Import Barriers. Imagine having to complete 16 different forms for each product you import and go to 10 different authorities. Some officials make it clear that they can only speed up the processing time by you paying them an additional fee.
- Applications. If you want to start a project requiring approval, such as a production facility, you cannot simply send the required application documents by mail to the capital. Chances are high that the documents will never arrive there. Any correspondence must be made by courier.
- Who you know. If you meet all the requirements for approval, it may happen that you will still not be granted the approval, either without stating reasons or by inventing further conditions that have no legal basis. Legal claims are not worth the paper they are written on, unless you have personal, good contacts with the government.
- Lawsuits. You can now sue, but either the process is dragged on for years or takes an unlikely outcome through illegal interference with the judges. An orderly settlement of disputes in a regulated procedure is not possible, neither in between you and the state or another private party nor with regards to in labor law issues. However, especially smaller companies and business owners cannot afford expensive arbitration.
- Loans and collateral. You also cannot receive loans on acceptable terms because you cannot provide collateral. Even if you plan to use some property, it’s not clear that property actually belongs to you. Although you have purchased it and are recorded as an owner in the register, several other parties claim they have the same right. Earlier register entries and records have often disappeared. The legally binding acquisition of property is massively difficult or highly complex. As a result, no loans can be taken, which could then be invested in existing companies or could be used for start-ups. This is a fundamental problem of many developing countries; The Peruvian author Hernando de Soto has repeatedly pointed this out, namely in his famous book The Mystery of Capital.
- Police. Local co-workers advise against calling the police in case of burglary and violence, as this is often a bigger problem than ordinary crime. Policemen are often poorly paid and improve their salary with protection rackets and other little benefits. However, not every company can afford a private security service.
- Politics. All contracts with the state and the laws governing your economic activity could well be obsolete after the next change in government. That means the sort of long-term legal certainty — and thus predictability — is absent. In the absence of certainty and predictability, investors keep their distance.
The latter point can be overcome if larger projects, in particular, are protected by international investment protection agreements and arbitration clauses. However, this path is inaccessible for domestic companies. Equally inaccessible to them is the Chinese variant, which clearly negotiates the conditions under which Chinese companies operate in the country. Violations by the partner state lead to the loss of China as an investment and trading partner and are therefore rare. That works. In fact, despite the clear self-interest, China’s economic engagement has brought more developmental progress in Africa within a few years than decades of planned-economy-style development aid.
Software is more important than Hardware
But there is a third way. Inspired by Nobel laureate Paul Romer’s theory of growth and his work on charter cities, it has become clear that the legal and administrative framework, the “software” so to speak, determines whether or not a society will prosper. The right “software” (legal frameworks, institutions) is far more important than the “hardware” (e.g. infrastructure).
Now, in many developing countries, conditions are such that despite the presence of a few capable individuals and entrepreneurs, large-scale reform is either completely ruled out or their local implementation is doomed to fail. We will not further explore why this is the case, but instead, take it for granted. The legal institutions are simply not hospitable to sustainable entrepreneurial activity. Therefore, Romer proposes to set up Hong Kong-style charter cities, which have an autonomous legal system (in the form of a charter; hence the name). These autonomous legal systems will have their own administrators charged with the task of implementation. According to Romer’s original model, an industrial state sends out these officials and establishes the legal system. He refers to this model as “Canada creates a new Hong Kong in Cuba”. The problem with Romer’s model is that no state wants to have what would appear to be a foreign administration in their own country. Also, this provides the usual suspects with ammunition for allegations of neo-colonialism.
Free Private Cities
One solution, then, is to establish privately managed special zones based on the concept of Free Private Cities. Free Private Cities are a kind of “special economic zone plus”, meaning partially autonomous areas led by an international operating company.
This company would operate according to worldwide proven legal and administrative standards. For a yearly fee, in the role of a “public service provider,” the operating company guarantees protection of life, liberty, and property. This includes a basic infrastructure, police, fire brigade, emergency rescue, a legal framework, and independent jurisdiction to allow residents to enforce their legitimate claims through a regulated process. All residents receive a written “Civic Contract” from the operating company, which guarantees the mutual rights and obligations. This includes the services to be provided by the operator and the modest fee to be paid, as well as the applicable rules and the inalienable rights of the residents. Disputes over the content and interpretation of the civic contract can be taken before independent courts or arbitration. Participation is purely voluntary and can be terminated by the resident at any time.
What is the advantage of such a private administration? Above all, the incentives for the operator are fundamentally different from those of traditional political systems. First, the operator has an immediate economic interest in the success of the community. Second, like any contractor, he can be held liable for mistakes. He cannot disguise his responsibility or pass it on to third parties. Thus, he bears his own financial risks. Third, he faces direct competition. He cannot force customers to accept his product but must find buyers who find his offer attractive and feel secure that he will abide by the contract.
This basic model can be transferred to special zones in Africa to provide a reliable legal framework and security on the ground that does not disappear after the next change of government. Such special zones, whether they are now referred to as Free Private Cities, super-economic zones, prosperity areas or otherwise, create opportunities for residents to acquire and own land, import and export goods, as well as to legally found and operate companies. These are the characteristics usually missing in these countries, which hinders economic development.
Special zones, therefore, offer the best prerequisites for ensuring a secure life and economic advancement for potential migrants to remain within their own cultures. These zones can attract companies from neighboring areas and from around the world. Entrepreneurs and investors who have avoided a region due to legal regime instability will now be interested in a stable environment ready to host new markets.
[perfectpullquote align=”right” bordertop=”false” cite=”” link=”” color=”” class=”” size=””]Though no zone is likely to be a Utopia, it would represent a stark contrast to refugee camps, for example, which are costly to maintain and devoid of formal institutions that encourage permanent settlement and entrepreneurial activity.[/perfectpullquote]
According to international law, such special zones would still be part of the host state, but technically they represent special administrative zones maintaining their own rules, their own jurisdiction, and their own security forces. It would be comparable to the status that Hong Kong or Macau have vis-à-vis China. In this setup, parties can agree to a certain amount of time, a period long enough to give security to residents and investors—say 50 or 99 years. After that, the host nation can schedule a vote by the residents on the fate of the zone for example. Ultimately, it depends on what can be achieved by negotiating with the host country and what incentives it has to agree to such an agreement.
The only way host states can be won over to such an approach is if they can expect clear benefits from it. When we consider some success stories, we should note that a belt of densely populated and prosperous areas has formed around the city-states of Hong Kong, Singapore, and Monaco. These prosperous surrounding areas belong to the host states. If such metropolitan areas emerge in a previously underdeveloped area, then this would be good business for the host country as well. Imagine a new Hong Kong or Dubai emerging in Africa! This would have significant positive effects on all nearby communities.
Putting in place basic infrastructure, security forces, administration, and a judicial organization requires significant funding. Given the political component of the project, it is obvious that potential immigration countries would provide financial support, such as giving loans to the operating company. This would not be a bad deal, as it is estimated that the cost of mass immigration to Germany since 2015 amounts to at least € 30 billion per year. With this amount, one could set up several special zones in the areas most in need of reform, which – after a start-up period – would financially sustain themselves and, if successful, could even repay the initial investment. Though no zone is likely to be a Utopia, it would represent a stark contrast to refugee camps, for example, which are costly to maintain and devoid of formal institutions that encourage permanent settlement and entrepreneurial activity.
The administrative activity, including the municipal services, is carried out by the operator himself or assigned to a relevant experienced general contractor. This contractor in turn may use sub-contractors for the various tasks (garbage collection, road construction, etc.). This corresponds to the Sandy Springs model, named after the city near Atlanta, USA, which has privatized all public functions and, after ten years, concluded that the quality of urban services has consistently increased. The costs, though, have decreased by 10-40 percent, depending on the respective public service sector. Even private security service providers are already working in a police function when it comes to ensuring security and order in special economic zones.
The operator of such a zone also provides a civil law system including courts. The idea is to adopt a proven legal system that offers investors security and is suitable for promoting economic prosperity. Examples include German Civil Code or English Common Law. Legislative precedents such as the Dubai International Financial Center and Abu Dhabi Global Market, which have introduced common law-based jurisdictions including courts, are also in evidence for a successful import of foreign legal systems.
It is important that such special zones also provide incentives for the settlement of skilled and educated individuals, entrepreneurs, and investors. Zones whose inhabitants consist exclusively or predominantly of unskilled people are unlikely to succeed. Therefore, every single zone must be able to approve its inhabitants in order to achieve a healthy mix of migrants suitable to a dynamic emerging economy. If the special zone flourishes later, additional jobs for the unskilled can be triggered automatically.
The operating company will certainly have to pre-finance the first years. But if break-even is calculated to be at 100,000 inhabitants and ultimately 200,000 persons come to settle, it will make profit. This is because police, legislative services, and infrastructure don’t have to be doubled in order to provide the same level of service.
If one does not want to go with a contribution model, then indirect taxes can be levied, in particular VAT or real estate-related taxes such as property transfer taxes. Ideally, the operating company has initially already acquired the land in the area of the special zone. The subsequent increase in land value alone may represent an opportunity to cross-finance other areas. If a particularly high surplus is generated, contributions could be reduced.
[perfectpullquote align=”left” bordertop=”false” cite=”” link=”” color=”” class=”” size=””]It is conceivable that over time, the inhabitants themselves become co-owners through the allocation of shares in the operating company. This would bring about an alignment of interests, as the residents would then not only have the right of participation and co-decision at the shareholders’ meetings of the zone operator, but also an economic interest in the prosperity of the special zone.[/perfectpullquote]
Different Incentives
The private structure of the zone avoids the risk that in the event of a victory through election, the winner will favor a group close to him or install a regime that jeopardizes stability or drives away companies and investors. Unfortunately, this is not an isolated case, as particularly evidenced by experiences in Africa. Due to the system, political (or religious) conflicts in the Special Zone are not created in the first place.
Nevertheless, the contractual rights and the human rights of the inhabitants are guaranteed. This is because all actions of the private administration are subject to the contractual agreements and can therefore also be reviewed in the courts. In addition, it is conceivable that the host state, other protective powers, and the residents send delegates to a public inspection commission, which ensures that the operator also complies with the rights guaranteed by the citizens’ contract. In addition to respecting fundamental human rights, it is important that the legal position guaranteed under the Civic Contract and the corresponding obligations are not unilaterally changed to the detriment of the residents.
As such, economic development, security, and stability get greater emphasis, compared to political participation. The latter can be introduced in a second phase, say after ten years, with the inhabitants then being able to choose the city manager or mayor or reject measures or rule changes through a referendum.
It is conceivable that over time, the inhabitants themselves become co-owners through the allocation of shares in the operating company. This would bring about an alignment of interests, as the residents would then not only have the right of participation and co-decision at the shareholders’ meetings of the zone operator, but also an economic interest in the prosperity of the special zone. The allocation of shares may, for example, be linked to a minimum length of stay in the zone, to the punctual payment of contributions or similar criteria that create incentives for good conduct.
When you can offer a greater likelihood of security, commitment to law and contract, personal and economic freedoms, shelter from political conflict, and the absence of corruption, it’s fare more likely a community will grow and prosper. They can give many people a perspective that they do would not otherwise have.
First real-world test in Honduras
The Central American state of Honduras is the first country in the world to embark on such a model. It has specifically changed its constitution and put in place a relevant law to create so-called Zones for Economic Developments and Employment (ZEDEs). These must respect the constitution and international agreements that Honduras has concluded, but otherwise have their own legislative powers, their own real estate and trade register, their own security forces and even their own courts. The initiative came from Honduran politicians and government lawyers, who had come to realize that the country, where the term “banana republic” was born, can barely be reformed for a variety of reasons. (Note: Paul Romer was also temporarily involved as a consultant.)
The ZEDE regime continues to operate for 50 years, even if the law is repealed. Honduras is also a member of the Central American Free Trade Agreement (CAFTA), which has its own chapter on investor protection, as well as respective arbitration proceedings. No matter who rules in Honduras, the country cannot afford to be thrown out of CAFTA. By contrast, a successful precedent could have a similar effect like the first Chinese special zone in Shenzhen. Many more followed, and basically China has become an economic giant through these special economic zones.
Günter Nooke, the adviser to the German Chancellor for matters related to Africa, has recently proposed to try the approach of special zones as “islands of good governance.” As expected, this was met with little love from the development-aid establishment, none of whom will benefit from these innovations. Of course, anything private is a no-go, and “no parallel structures” should be built up. But after 60 years of failure one should admit that without parallel structures, stagnation will continue. It’s worth a try and maybe we can also learn something from it for the benefit of our own systems.
Titus Gebel is an entrepreneur and holds a doctorate in law. He founded, among others, mining company Deutsche Rohstoff AG and is active on multiple continents. With his model of Free Private Cities, Titus wants to create something completely new in the “market of living together”. He has set up the legal framework for a special zone project in Honduras and is the author of “Free Private Cities: Making Governments Compete For You.”
Photo by Sarthak Navjivan on Unsplash.