LEAP Zones: Faster growth with less conflict

Starting over a decade ago, I began to share with a few leaders in the United States and Central America my concept of LEAP zones as an accelerated path to development, an outgrowth of my work doing economic reforms.

In Honduras, at that time, Porfirio Lobo headed the legislative branch, championing key reforms, and Octavio Sanchez, author of an important land registry and titling reform, was a legal advisor to the country’s president, Ricardo Maduro, for whom I was doing an innovative telecom reform that applied some LEAP principles.

Both Lobo and Sanchez were deeply focused on ending poverty in Honduras, and they were quickly drawn to the idea of LEAP zones because they saw how it could hasten that process.

I would work closely with Porfirio Lobo for a number of years, and in 2009, he was elected president of Honduras. His first week in office, we met in Tegucigalpa and, as before, I used a crude sketch to illustrate the scale of a LEAP zone. I drew a large oval to represent the full size of Honduras, and then on the “coast” made a dot that was so small it was barely visible.

Why an area so small? Although the design of a LEAP zone is quite different from that of China’s special economic zones, a vital lesson was taken from Deng Xiaoping: a full break with a poorly-performing but fairly stable national system will face less resistance if done in an empty area. The people will come voluntarily.

There is no need for a frontal attack on the interests of those who depend on the current system. The transformation of China began by first bringing a new system to four tiny SEZs that were too small and too empty to fight over.

To produce great changes, the size of the land is not important, but the stature of the leadership is vital. In Honduras, President Lobo formed a small team to design an historic amendment to their constitution to permit the creation of these new, special jurisdictions. If successful, their LEAP initiative“Zonas de Empleo y Desarrollo Económico” will change the way development is done around the world.

President Lobo chose as his chief of staff Octavio Sanchez, a Harvard-trained lawyer who would lead the reform together with Ebal Diaz, who played a key role in crafting the complex statutes, and Carlos Pineda, who focused on investor protection and the role of institutions.

An event as important as the election of President Lobo, was that the brilliant young politician Juan Orlando Hernandez became president of the legislative branch. Given the strong political antagonisms in Honduras, any major reform faced a treacherous path in Congress. Yet the constitutional reform passed with nearly unanimous votes, transcending the divisions of party and of ideology, as even the Left voted in favour, a great testimony to the legislative leadership of Mr Hernandez.

It was, as they say on Broadway and Wall Street, “an overnight success, a decade in the making”. Not surprisingly, artful versions of the history and paternity began to appear. A prominent, media-savvy American economist who held somewhat similar ideas quickly began to publicise the Honduran LEAP initiative.

As international awareness grew about the reform, a growing number of thinkers came to see the project as something important beyond just Honduras, among them two Nobel economists, one declaring himself a “friend of the project”, writing that “LEAP is just incredibly intriguing”, and another offering to help in the governance of the zone.

A BBC interviewer came to Honduras to tape a special edition of the flagship programme HardTalk. Insisting on verisimilitude, the producer drove us about 90 minutes from San Pedro Sula to sit us down in a hot, humid, sunny spot beside a stream, where pigs and chickens wandered about.

After questioning me whether the country’s LEAP zone initiative was a throwback to colonialism, or might usher in the return of the company town, the interviewer leaned forward and asked me if, in reality, the Honduran leadership was not just spinning its wheels in some utopian fantasy.

“Utopian?” I replied. “Not at all. In fact, the Honduran reform makes me think of Britain’s Glorious Revolution of 1688.”

Hearing that the interviewer, a Cambridge man, could barely contain his laughter. Perhaps imagining I had gone batty in the heat, he exclaimed “You can’t be serious!” Well, I said, perhaps some people believe that nobody but the English are capable of such historic feats.

Alas, that brief exchange was not included in the final edit, missing a chance to explain to BBC viewers in 200 countries the importance of rule of law in promoting economic growth.

Of course, the entire conversation with HardTalk – and this point should be obvious – would have been inconceivable had the topic been the commonplace, though functional, “free zones” that exist by the thousands around the planet, with names like: free trade zone, free economic zone, special economic zone, export processing zone, industrial development zone, maquiladora, bonded factory, enterprise zone, free port, zona libre, zona franca, porto franco, Freihafen, and so forth.

Whereas an SEZ is a special economic zone, a LEAP zone is a special legal, economic, administrative, political jurisdiction.

To visualise the difference of a LEAP zone, whether from the point of view of government policymakers or private investors, think of a chair with four legs.

Economic leg

One of the four legs is the “economic leg”, and it is about things like tax rates, duties, capital rules, labour regulations, and so forth. If we design a zone that focuses just on economic policy, disregarding the other three legs, we will create a special economic zone, in effect a chair with one leg.

But what if we take a page from Lee Kwan Yew, the founder of modern Singapore, and now add a “legal leg?”

Lee, trained as a British lawyer, understood that to attract investors to newly independent Singapore, rule of law was no less important than financial incentives, and that world class, independent, judicial institutions were the sine qua non of investor confidence.

Legal leg

The “legal leg”, to be clear, is much more than the statutes. The far bigger issue is: who are the judges? Under what judicial culture do they operate? What is their track record? What makes us believe that they will be fair and independent?

The conundrum is that for highly credible institutions to evolve from scratch requires a period of time that exceeds a human life span. So the LEAP model makes use of what we call “institutional leapfrogging” – and this is a different use of the word “leapfrogging” than one finds typically in development economics.

Unlike the familiar concept of technological leapfrogging (whereby the newest innovations are applied, skipping the earlier technologies), with “institutional leapfrogging” rather than seeking newness and innovation we draw upon the most well-established institutions, often the oldest ones and certainly the most credible ones, making direct, immediate use of them as service providers.

At the outset, “institutional leapfrogging” can mean using the world-class judges and courts and dispute resolution venues and mechanisms that already exist and in which investors already have confidence. In other functions, such as environmental permitting, the most credible, international experts might be hired to directly provide the service, not retained as consultants to train local officials or recommend improvements.

The essence of “institutional leapfrogging” is that to have superb institutions is not a goal or objective in a LEAP zone: It is the starting point. By analogy, Federal Express could not open for business promising that one day it might be able to efficiently deliver packages; the starting point was to first have in place that capacity, to be able to absolutely, positively deliver.

In the legal area, we can do this through “judicial out-sourcing” or “judicial in-sourcing”.

In the case of Singapore in 1965 and for two decades thereafter, and Hong Kong until 1997, or today in the Cayman Islands, Mauritius, Bahamas, etc the application of institutional leapfrogging is the use of the Judicial Committee of the Privy Council in London as the final appellate court, an example of “judicial outsourcing”.

Other leapfrogging applications rely on “judicial in-sourcing”, as in the case of Hong Kong after 1997 or the Dubai International Financial Center since 2006. Others may use arbitration venues in London, Paris, Washington or elsewhere.

Starting in 2000, when I first presented the LEAP model in El Salvador, and a few years later in Honduras the political acceptance of judicial out-sourcing was a sticking point. A big change came after 2006. That year CAFTA took effect, which applies “judicial out-sourcing” through international arbitration for cases arising anywhere in the country, but only for the benefit of foreign companies. Suddenly, to have this option available on a non-discriminatory basis in an empty 1 per cent of the national territory hardly seemed radical.

The same initial objection to judicial out-sourcing appeared last year in Tbilisi, when I presented the LEAP model to the government leadership in Georgia. Once properly understood, however, the reform went forward, Georgia passed a constitutional amendment, and their president announced that British Law would be applied in a special zone to be established on the Black Sea. Now, with a new government in power in Georgia, it remains to be seen what will happen.

Administrative leg

A third leg in our chair corresponds to the administrative function, or in general terms the executive power.

To savour the relevance of this third leg, here is a list of complaints drawn from a US State Department country report, something I reviewed in preparation for a series of public presentations on LEAP zones in the Balkans: ”Improper enforcement of legislation, entrenched bureaucracy, frequent changes and lack of transparency in regulations are all a burden for the business community. Foreign investors often note that lack of proper law enforcement and bureaucracy leads to the prevalence of corrupt procedures and practices.”

Reading that last paragraph one realises that the most seductive, incentive-rich, investment promotion law, may be but a siren song if the Administrative function is not in good, credible hands. A LEAP zone creates a unique internal administrative model and culture designed to facilitate doing business, built to function at the speed of 21st century technology and markets, and not the speed of 20th century politics and bureaucracy.

Political leg

Then there is the fourth leg, the “political leg”, that is nothing less than the stability of all the arrangements that an investor must rely upon.

In its finest expression it will mean a responsive system of governance that assures stability and transparency under rule of law. At a minimum it must mean that the system is not at risk of being up-ended every time there is a change in the national government.

Any number of well-known public institutions are designed to provide stability and to impede politicisation or demagoguery. For example, the US Federal Reserve Board and the Panama Canal Authority are intentionally insulated from the volatility of election campaigns and national politics.

A LEAP zone should not be imposed on top of a community. Instead, those who wish to may move to a new, start-up zone.

A new zone may be structured, for instance, to be a stable platform for receiving long-term investment, for producing value-added exports, for quality employment. To achieve that a small semi-autonomous investment jurisdiction is created, with unique internal governance structures that are designed to give confidence to investors that there will be stability under rule of law. As an example, a board of trustees can be combined with multiple guarantees of stability, such as treaties and various redundant mechanisms.

The LEAP model grew out of my real-world experience helping countries do economic reforms. In my application, LEAP zones make use of what is already proven to work; they are neither utopian nor experimental, but just bring together the most successful arrangements that imperfect human societies have created and been able to sustain across historical time.

We need not bet on new untested ideas, but we do need a new way of thinking so that we can efficiently apply, in small empty areas of land, for those who choose to go there, the best proven solutions that already exist.

If we do that, a large part of the world’s population can live the miracle that places like Singapore, Hong Kong and others have proven is possible: a century of progress in a single generation.