Build state capacity by building charter cities

28th August 2020
Issue 1

Many low-income countries are unable to provide effective governance for their citizens, trapped in a cycle of slow growth and persistent corruption. Charter cities may provide an answer.

Politics

Covid-19 has laid bare the differences between countries. Some countries seemed powerless to react to the deaths sweeping their country. Some snapped into action, slowing down and then snuffing out the virus. This was due to to state capacity—the ability of a government to build new hospitals, organise an army of contact tracers, and set up airport testing. Western institutions are broken and moribund and there is little we can do within them to build more. The answer is a new start. America started afresh with a new constitution once before—citizens of the world can do this today.

A charter city is a new city with a special jurisdiction that grants a wide range of autonomy. The blank legal and administrative slate allows the charter city to truly start from scratch, to build new institutions that are more responsive to residents and businesses, instead of being moribound and tied to existing bureaucratic sclerosis. A well designed charter city would have a government capable of acting, providing rule of law, public goods, and effectively fighting pandemics.

The idea of state capacity, until recently confined to academia, is increasingly cited in policy discussions. State capacity, to introduce a working definition, is the ability of a government to accomplish tasks in a timely and efficient manner. These tasks could include things like building bridges, passing and enforcing new legislation, or responding to a pandemic. State capacity can be thought of as a social technology.

To take a simple example, we can compare the efficiency of two governments building a road. All else equal, the government which was able to build the road more quickly would be said to have higher state capacity. Advocates of state capacity suggest that competence in building a road is correlated to other competencies in governance. A government that is good at building a road tends to also be good at building a bridge or even administering a vaccine. Thus, we can talk about state capacity as a singular thing, rather than state’s simply having discrete skills at certain tasks. Having this thing, state capacity, allows for the provision of public goods as well as fair and efficient dispute resolution. Indeed, it is one of the foundations of a successful society.

It is important to clarify that state capacity is not necessarily related to the size of government. It is possible to have high capacity with a small state, as well as a large state. Singapore has a relatively small state for a high-income country. However, their government is effective and would qualify as high capacity. The Danish government, on the other hand, has a large state, spending a high percentage of their GDP. However, Denmark also has high state capacity.

While state capacity tends to be correlated with a country’s income, it is possible for low income states to have high capacity. Boston, Massachusetts, for example, deployed public hand sanitizing stations in May. Kigali, the capital of Rwanda, had them in March. While this example is somewhat trivial, it shows that a state that can execute tasks competently is achievable even at low income levels. However, most low-income countries are not so well-governed as Rwanda.

It is also important to distinguish state capacity with state priorities. State capacity, like power in general, can be used to good and bad ends. China, for example, has high state capacity. Sometimes they use this capacity for good, like building new infrastructure that improves productivity and reduces poverty. Other times, however, they use their capacity for bad, like locking Uighurs in concentration camps or limiting the rights of Hong Kongers.

Building state capacity is a necessary institutional ingredient for supporting economic growth. Thus, building state capacity is the most pressing development challenge of the 21st century. A government that is unable to provide public goods will keep its population mired in poverty. A government which is able to support rule of law, open markets, and infrastructure necessary for economic activity, will become successful.

Introducing charter cities

A charter city is a new city, built on greenfield land, that possesses a special jurisdiction to create a new governance system. Charter cities can be a tool to improve state capacity. Many low-income countries are impoverished in part because they lack state capacity. They are unable to provide public goods, including infrastructure, security, dispute resolution, or governance. The result is limited foreign investment, continued corruption, and little economic growth. Reform to improve state capacity is difficult, as entrenched interests and a culture of bureaucratic sclerosis can be difficult to change. With apologies to Gordon Brown, ‘in establishing state capacity, the first five centuries are always the hardest.’

Why exactly is this? In The Logic of Collective Action, economist Mancur Olson develops a theory of political action in which policies that are socially harmful are able to persist when the benefits of those policies are highly concentrated and their costs are diffuse. Sugar subsidies in the United States are a classic example of the logic of collective action in practice. The subsidies are harmful—consumers pay higher prices for sugar in the US than in the rest of the world—but the annual cost imposed on each person is about $10. Organizing national political action to repeal an obscure policy that costs each of us $10 is a near-impossible feat. However, for the small number of sugar producers that collectively receive benefits in the billions of dollars, political action to stymie reform is far easier.

In many lower-income countries, as well as some high-income ones, politics are tightly controlled by a small elite and public political voice is very limited. This only further amplifies the challenges of overcoming collective action problems brought on by rent seeking and regulatory capture, either by private business or by the bureaucracy itself. Over time, this gives way to a second problem also identified by Olson, this time in The Rise and Decline of Nations: institutional sclerosis.

Bad policy accumulates over time, and although such policy is easy to introduce, we know that repealing it is exceedingly difficult. As the roster of bad policy grows, so too does the collective weight of its costs. While the costs of any one policy are not likely to substantially change growth rates, hundreds or thousands of such policies will. The difference between 50 years of three percent growth and 50 years of two percent growth translates into huge sums of potential income lost for the average person. Starting from a baseline income of $2,000, annual income at the end of the first scenario is $8,768, but only $5,383 at the end of the second scenario.

Poor countries that make good policy choices, like China, have seen sustained growth well above three percent for decades, while nations that accumulate bad policy remain poor. The direct costs of rent-seeking policies are enormous. But there are non-trivial indirect costs imposed as well. Anne Kruger identifies the cost of defending highly valuable economic rents as a major economic cost.

These challenges are preventing needed investment in infrastructure. The African Development Bank estimates that each year, the continent faces an annual collective infrastructure financing deficit of $68 to $108 billion. While the US and other wealthy nations were able to develop extensive road networks and sufficient electricity generation long ago, these basic infrastructure needs have never really been fulfilled in a systematic way throughout the Global South. If low-income countries remain incapable of creating an enabling environment for economic growth and developing the infrastructure needed to support massive urbanization, their next century will be nothing short of disastrous. Economic mobility and poverty alleviation will stall while slum housing and informal economies continue to grow. Charter cities provide one tool to help change this trajectory for millions of people and overcome the institutional problems that inhibit growth and state capacity development.

Charter cities start from a blank slate in law and administration. They allow for the building of new systems. These new administrative agencies can be designed for action and efficiency, they are not bound by existing institutional infrastructure. In other words, charter cities can help build state capacity in select regions in low income countries, overcoming typical challenges to institutional reform.

Charter cities, by creating a blank slate, can help solve these challenges. Under ideal conditions, the host country devolves all governance authority to the charter city with the important exceptions of criminal law, constitutional law, and international treaties. Charter cities are not sovereign, nor do we propose having a high-income foreign country administer them as was proposed by Paul Romer a decade ago.

We instead view charter cities as a public private partnership between a private developer that owns the land and is responsible for building out the infrastructure and the host country government. The city government is created by splitting voting rights between the developer, the host country, with other parties added as necessary.

Granting the developer governance decision-making rights aligns their incentives with the long-term incentives of the residents and businesses of the charter city. The developer recoups their investment over several decades through increased land values, the result of increased economic activity. In exchange for the devolution of authority, the host country’s government benefits from investment, economic activity and a share of the tax revenue of the charter city.

Building a new city and a new governance system from scratch allows a charter city to overcome the political difficulties of implementing deep reforms in an existing jurisdiction. Starting from scratch on undeveloped land ensures that living in a charter city is voluntary and that reforms can be implemented without pushback from the existing bureaucracy or disturbing the existing structure of rents. A charter city can use its widespread authority to introduce a governance system conducive to both local growth and foreign investment that sidesteps Olson’s challenges to reform. Hopefully, a successful charter city can help the host country foster the political will to implement similar reforms and improve its own bureaucracy.

Charter cities in history

Shenzhen is perhaps the best example of a charter city-like development. Introduced as one of four special economic zones in China in 1980, Shenzhen was built up across the border from Hong Kong in an area previously occupied by a few hundred thousand people in a collection of small villages, but with no substantial industry of any kind. Decision-making authority was devolved from Beijing to local officials, who established China’s first land and labor markets in Shenzhen. Market mechanisms for the purchase of daily goods were introduced. Foreign firms and banks could establish branches in Shenzhen, and a stock exchange was set up in 1987. Shenzhen became a leading hub for manufacturing, starting in simple products like textiles and later moving on to more complex products like electronics.

This devolution of authority empowered the Shenzhen government to act effectively. They were no longer constrained by mandates from the central government. Instead, they took action to attract foreign investment and create jobs.

Reforms pioneered in Shenzhen were later replicated throughout the rest of China because of their incredible success. Through a strategy of special economic zones and urbanization, over 850 million people have been lifted out of extreme poverty in China over the past 40 years. Today, Shenzhen is a metropolis of 20 million, wealthy even by global standards. Relaxing excessive levels of political control that had left the government with very limited state capacity enabled the Chinese government to learn how to effectively use its power to support growth. By devolving authority to local officials and allowing them to experiment with policy, China learned how to effectively develop market-supporting institutions and plan for substantial urbanization, something it never could have successfully done in the pre-reform era.

Singapore and Dubai also stand as inspirations for charter cities, especially for their economic foresight and integration into broader economic trends, as well as for developing effective states. When Lee Kuan Yew became Prime Minister of Singapore in 1959, he quickly recognized that long-term growth based on a freeport and tourism would be inadequate, and that industrialization would be needed. Lee pursued economic liberalization and was able to attract American and other foreign firms to invest heavily in the young country. The Singaporean government possessed the capacity to make the infrastructure investments necessary to support a growing industrial base and had established a booming manufacturing sector by the 1970s. As the sector grew, so did the complexity of the products manufactured in Singapore. As an effort to bolster investor confidence, Singapore used the British Privy Council as its superior commercial court until the late 1980s, effectively importing foreign state capacity when its own was limited. Investors in newly independent Singapore might not have fully trusted a Singaporean court to enforce the rule of law, but they certainly trusted the United Kingdom to do so.

However, Singapore didn’t just open up its markets. It inculcated a culture of excellence in governance and created a bureaucracy that is responsive to the needs of the public. Singapore is regarded as one of the least corrupt countries in the world. It developed a world-class public housing scheme and has successfully utilized congestion pricing since 1975, something not all countries have successfully been able to do. When Singapore’s government sets out to execute a complex task, one can be confident that it has the financial and technical capacity to do so successfully.

Although its economic history is quite different from Singapore’s, Dubai also provides an excellent example of the importance of foresight and adaptability in building state capacity. When Sheik Rashid came to power in 1958, Dubai was a small port town of 60,000 with very limited infrastructure. Rashid immediately began to invest in making Dubai a better place to live and do business. The port capacity was expanded, and electricity and running water was made available to every building.

Oil was discovered in 1966, however, it was quickly recognized that Dubai’s limited oil reserves would not last forever and that economic diversification would be needed. After the oil was discovered, Rashid famously said, “My grandfather rode a camel, my father rode a camel, I drive a Mercedes, my son drives a Land Rover, his son will drive a Land Rover, but his son will ride a camel,” signaling just how seriously he took the need to diversify over the long run. Rashid rapidly built up Dubai’s state capacity to develop market supporting infrastructure and institutions, necessary for the emirate’s economic survival over the long run. Most of Dubai’s neighboring emirates and countries have either been less economically successful, or are wholly dependent on oil revenues, because of their limited state capacity to develop new economic opportunities.

Over the next several decades, the Jebel Ali Port (one of the largest in the world) was built, as well as a major drydock. Tourism became a major sector for Dubai, and the Emirates airline was established. To strengthen Dubai’s position as a major financial center, the Dubai International Financial Centre (DIFC) was established in 2004 as a free zone with its own English common law-based commercial court. The DIFC has established itself as one of the most successful purpose-built institutions and has made Dubai the premier finance hub for the Middle East and among the best in the world. To support Dubai’s rapid growth in services and commerce, many talented foreigners have been permitted to live and work in Dubai to compensate for the small local population.

Dubai’s tradition of innovative governance goes back much further than the DIFC and Sheik Rashid. At the turn of the 20th century, Dubai became a freeport to attract Iranian traders facing new taxes in their own country. In the 1970s and 80s, Dubai again became a refuge for Iranian entrepreneurs, academics, and liberals following tariff increases and the 1979 Revolution. Because Dubai built up state capacity under Rashid, it has regularly been able to build key infrastructure, develop new institutions, and nimbly respond to mistakes by neighbors, all of which are necessary for a small desert city state to thrive for as long as Dubai has, without deep oil reserves. While each did so in a unique way, Dubai and Singapore both demonstrate the importance of a forward-looking and flexible state that can execute on the complex tasks it intends to.

Charter cities in emerging markets

Although they all started out quite poor, Shenzhen, Dubai, and Singapore achieved great success. Many emerging market countries today are struggling to achieve similar outcomes, but a few seem to be getting things right. Part of this is priorities. Nigeria, for example, cut investment in universities under a military dictatorship as universities were a core area of dissent. However, some of the challenge is capacity. In working with governments in emerging markets we have seen resource challenges and ineffective bureaucracy as holding back investment and growth.

Ethiopia’s Hawassa Industrial Park has been highlighted as one of the few African special economic zones to generate substantial investment and employment. The emergence of manufacturing in Ethiopia has even prompted discussions about the country becoming the “new China” for low cost manufacturing.

Along with Rwanda, Botswana stands out as a model of good governance in Africa. It avoided falling to the typical “resource curse” with its diamond industry and has been able to invest extensively in infrastructure, education, and health and is now one of the wealthiest countries on the continent. The “pockets of effectiveness” literature has identified notable examples of effective state institutions within otherwise poorly functioning states, showing that capacity building is possible within a state that generally functions poorly. Ghana’s Ministry of Finance is one such example, having been praised for the country’s strong macroeconomic performance and responsible budgeting in recent years.

These success stories are unfortunately too rare. That’s where charter cities come in. Although there are hundreds of new city projects around the world, only a handful appear to be taking matters of governance and economic development seriously. By combining governance reforms with existing new city developments, it is possible to introduce reforms which instantly transform the governance capacity of a region. These reforms can stimulate investment and accelerate job creation, becoming key to economic development.

Enyimba Economic City, Nigeria is one of these new cities. It is planned for 1.5 million people and will be a manufacturing and trade hub for West Africa. It has already secured a unique special economic zone status devolving substantial authority, and construction is expected to begin within the next year, though Covid-19 has introduced uncertainty.

Other new city developments are focusing on services, bypassing manufacturing in the global value chain. Nkwashi, a Zambian satellite city of Lusaka for 100,000 residents, intends to focus on developing a services economy based around a new university. The planned university will train students in computer science and other related areas to fill the growing demand for skilled professionals that can work remotely in Africa. Nkwashi’s first residents are slated to move in within the next year.

While projects like Enyimba Economic City and Nkwashi don’t need governance reforms to be successful, those governance reforms can help transform the projects from successful business ventures to key contributors to economic development.

A successful charter city will create investment and economic growth, but also provide a model for what effective government looks like that the host country can directly learn from. Young administrators could want to cut their teeth in a fast, competent charter city, before being promoted to a more senior position in the national government. Resource and information sharing could demonstrate that effective governance is not reserved for Europe and East Asia, but possible for all people.

This is not to underestimate any of the challenges of creating a charter city. From getting political buy-in, to acquiring land, to fundraising, to building a new governance system, it’s really hard. Charter cities can help turn those centuries into years, accelerating economic development to allow all humans to flourish.