Sunday, October 4, 2009

Why charter cities may not take-off?

For sometime now, former Stanford Professor and pioneer of the New Growth theory, Paul Romer has been advocating the setting up of Charter Cities - a new city set up in an unoccupied piece of land, with population, material and financial resources imported from elsewhere, and whose deployment is governed by a set of rules or a charter. One government provides land and one or more governments grant the charter and stand ready to enforce it.

He has proposed three examples of possible charter cities - US handing over the part of Cuban terriroty adjoining Guantanamo Bay to Canadian government which undertakes to develop it along the lines of Hong Kong; Australia could set aside a part of its territory to be populated by Indonesian immigrants and administered by Australia in consultation with the Indonesian government; and development of a special zone with a charter of the Government in India, to be developed by one state government after a competitive bidding process among all states.

In a recent article (via Mark Thoma), Prof Romer clarifies on the tradeoff between faster growth and higher risk that charter cities would face. He draws the distinction between rules (or rule set) which emerges and gets refined through "an evolutionary dynamic based on small, incremental changes or through a new-system dynamic in which an entirely new rule set enters and competes with an existing one", and catch-up growth (based on copying existing ideas) and frontier growth (involves the discovery and implementation of new ideas).

Catch-up growth with an evolutionary dynamic, while being the least risky (in so far as there is least uncertainty about its trajectory and outcomes), is more likely to be very slow and not effective. However, in catch-up growth, the new-system dynamic can be used to copy existing rule sets, thereby allowing for faster growth without the additional risk that comes from using the new-system dynamic at the frontier (which are innovative and hence risky). Therefore, charter cities embrace catch-up growth with a new-system dynamic, and "adopt a new rule set made up of rules that are known to work well... (and) accelerate catch-up growth with little of the risk associated with the development of new systems at the frontier".

Presumably, the main objective of the Charter Cities would be to bring about a faster pace of development (by more effective administration with a set rules outlined in a charter) to areas within or adjoining developing countries by leveraging resources from across the world and the administrative efficiency of certain neighbouring national governments with a creditable track record for delivering on economic and social development.

It would be less of an attraction for many of the developed countries, since their governments already have a competence in effective administration. Further, their private sectors can be incentivized to leverage the local resource strengths and deliver of even frontier growth with a new-system dynamic.

This effectively means that Charter cities are a collaborative experiment between one or more developed and developing countries, which seeks to incentivize developed country governments to participate in a joint development effort (with a developing country) with the attraction of the profit opportunities that exist in such co-operation. I am not willing to countenance any arguement that would bring in attributes like altruism and internationalism into the motivations as driving national governments.

In view of the aforementioned, let me play the devils advocate on charter cities with the following observations.

1. Charter cities lay great faith in the ability and commitment of national governments to formulate charters and enforce them. However, there is little evidence nor sufficient enough economic or political rationale for reposing such huge faith in governments, especially foreign governments to administer and enforce a charter that also benefits another country and its citizens.

Further, there exists the real possibility that the foreign administrators could end up skimming off the cream and a disproportionate share of the benefits of development. No charter, however comprehensively framed to pre-empt all such possibilities, can prevent such an eventuality, should the government of the administering country (or the establishment that controls it) so wish. The possibility of Colonialism 2.0 becomes very real.

2. There is the very strong possibility that charter cities set up beside the poorer countries would end up cherry-picking the skilled human resources and investible capital away from the mainland (of the developing country). It is natural that the skilled professionals - doctors, scientists, teachers, engineers etc - and investors would gravitate towards these new areas, further impoverishing the poor country.

This would be something similar to the new townships (or "gated communities") or satellite towns that are proliferating in the suburbs of many of the metropolitan cities in countries like India, which act as a magnet in attracting the rich and skilled and the major share of investments in institutions relating to education, health care and other services.

Alternatively, the proximity to the under-developed and poorer areas can also have the effect of keeping away private investors, wary of the political repurcussions of events in the mainland and the possibility of spill-over or contagion from disturbances there.

3. The examples of the numerous world-class Chinese cities that have developed in the last two decades is misleading. They are more closer to being examples of catch-up growth cities with an evolutionary dynamic, albeit a break-neck pace of evolution during recent years, than catch-up growth following a new-system dynamic as suggested by Prof Romer. None of these cities emerged from thin air, but were the result of focussed government policies and driven by specific growth engines that catapulted the originally existing small to middling cities into a much higher growth trajectory. To that extent, they are more evolutionary than new-systemic.

4. There is something disconcerting about the fact that charter cities would need more than economic incentives to ensure its success. As mentioned earlier, it is unrealistic and not borne out by historical evidence to place such faith in a foreign government's commitment to the charter and its outcomes. A more practical model would be a partnership with private investors.

In recent years, there have been a growing number of cities similar to the aforementioned charter cities, most notable being the spectacular Palm Islands in Dubai and the grandiose New Songdo City in South Korea. However, both these, and other similar developments, have been done by private investors with enabling policies set in place by governments. There is nothing mis-aligned about incentives in the development of such cities. Private developers who sense a profit opportunity leverage investments from investors looking for attractive long term returns, and governments benefit by the economic development and tax revenues (and also the rents by way of contracts).

The Special Economic Zones, Technology Parks and so on, that are part of economic development promotion policies in many countries, seek to build on precisely such partnerships with private investors and developers to develop and promote economic growth and development.

5. And finally, there is the issue of political acceptability that will come in the way of charter cities even if all the aforementioned challenges are surmounted. For example, a charter city in India administered by one state government will surely come up against local politics, in its various dimensions (for simplicity assume a city located in one state and being administered by another, with both states belonging to two opposing political parties). The possible incentive distortions that can derail such projects are manifold.

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