Monday, June 7, 2010

Charter Cities (it's all about the rules)

Besides the scenery and other small novelties, educational podcasts are one of my favorite pastimes on long car rides. After dropping my wife off at the airport in Orlando I popped in Econtalk (probably my favorite podcast) and listened to Paul Romer and Russ Roberts discuss "Charter Cities". I'd stumbled upon Charter Cities before, via a summary of Romer's presentation at a TED Conference (video here and pictured below), but, the podcast helped to more clearly define the nature of a charter city and why Romer believes they wield untapped potential for economic development.

What are charter cities? According to the FAQ on Romer's project website ( the basis for a charter city are, ". . . uninhabited land and a charter granted and enforced by an existing government or collection of governments. With the right rules, a city will naturally grow as residents arrive, employers start firms, and investors build infrastructure and buildings."  The notion of settling uninhabited land with a brief set of rules is not beyond the scope of history. William Penn settled Pennsylvania with a small set of rules, chief among them freedom of religion. The following is from the Pennsylvania Charter of Privileges,

BECAUSE no People can be truly happy, though under the greatest Enjoyment of Civil Liberties, if abridged of the Freedom of their Consciences, as to their Religious Profession and Worship: . . . I do hereby grant and declare, That no Person or Persons, inhabiting in this Province or Territories, who shall confess and acknowledge One almighty God, the Creator, Upholder and Ruler of the World; and profess him or themselves obliged to live quietly under the Civil Government, shall be in any Case molested or prejudiced, in his or their Person or Estate, because of his or their conscientious Persuasion or Practice, nor be compelled to frequent or maintain any religious Worship, Place or Ministry, contrary to his or their Mind, or to do or suffer any other Act or Thing, contrary to their religious Persuasion . . .

Again, the set of rules does not need to be complex but perhaps based on a couple of key principles. We will come back to the civil liberties in a moment, but in the TED video Romer identifies Hong Kong as a proxy charter city (more to do with their economic rules). Although Hong Kong was located in China it operated, with stunning success, under British rules for much of the 20th century.Seeing the success of Hong Kong, China established more "special economic zones" (SEZ) or "open cities". These zones have been very successful at attracting foreign direct investment. Further testimony to the success of some simple economic rules are how other countires have applied the blueprint of these business zones. Such countries include India, Brazil, Pakistan, and several others. With more favorable rules toward businesses significant growth has been attributed to these SEZ.

Before we talk about what kinds of rules help spur growth some background knowledge about Paul Romer might be important. How did Romer, a man that graduated with his PhD from Chicago, and an imminent macroeconomic scholar, suddenly find a new research agenda that looks at the adoption of rules? The short answer? Rules, how they are selected and discarded (as well as their more subtle evolution) turned out to be the burning unanswered question about progress. Technologies (the topic for which Romer earned his reputation) do not matter if the legal rules and social norms to facilitate trade and the exchange of ideas are not in place.(By the way, we care about growth because we care about the standard of living in these poor countries)

What helps the exchange of ideas? Free elections, freedom of speech, freedom of religion, etc. These all fall under the category of "civil liberties". Probably the most frequently used index to rate the vitality of civil liberties in a country is the Freedom House Index. These are rules that help facilitate the transmission of voter preferences through the political process and help to create an open space for ideas to be heard.   

What helps to facilitate trade? Security and Incentive. The economic environment must be secure to promote trade ---uncertainty scares investors away. And uncertainty can come through many channels: the court system and the macroeconomic environment. A sound legal system is needed to secure property rights (property could be on land, ideas, anything that belongs to you). Also, courts help enforce contracts which provides peace of mind in large business deals. Moreover, uncertainty can take place with respect to the macroeconomic environment with the devaluation of currency and poor access to money. The second part of  what helps to facilitate trade deals with incentives. How much of the benefits of trade does a person get to keep? That is, how much must they give to governments either via a trade barrier such as tariffs or in income tax? These can reduce the incentive for businesses to trade. Probably a good follow up to this discussion would be to glance at the Economic Freedom of the World Index.  

This discussion of the kinds of rules that facilitate trade and exchange of ideas have a common theme: freedom. Interestingly, Romer says that Charter Cities are all about choice. We want to allow people to enter/exit a city. And, with good rules this charter city will attract business, jobs, and people. Romer believes that a Charter City is more effective than a village and more politically palatable than changing a whole nation. Remember that whenever a rule changes there are usually winners and losers. That means that changing the rules on a national scale would likely invite fierce opposition. Romer believes a city is just the right size.

Finally, upon writing this blog post I became aware of two very good interviews. One of the interviews took place last year on the Aid Watch blog and another Q&;A with Romer on the Freakonomics Blog. There will certainly be more Q&A's in the future since there are so many unanswered questions and charter cities are a provocative idea, perhaps the best on a menu of otherwise undesirable and expensive development practices.

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