1. Introduction 1.1 Background

1.2 Objectives

1.3 Definitions

2. Existing Literature on SEZs 2.1 Overview of SEZs around the World

2.2 Potential Benefits of SEZs

2.3 Factors That Determine the Success of SEZs

2.4 A History of Success and Failure: The Cases of China, the United Arab Emirates, and India

3. The Potential Impact of a (Successful) ZEDE in Honduras

3.1 Previous SEZs in Honduras

3.2 First Method: Forecasted GDP Per Capita with (Historical) Chinese SEZ Growth Rates

3.3 Second Method: Forecasted GDP Per Capita with a Dynamic Regression Model 4. Conclusions 4.1 Opportunities to Change Honduras for the Better

4.2 Recommendations

4.3 Risk Factors

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Contents

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1.1 Background

The history of special and free economic zones is replete with both failure and success. As China inaugurated four special economic zones (SEZs) in 1984, the idea of SEZs gained popularity, especially as means to achieving far-reaching market reforms in poorer economies in which country-wide reforms were deemed politically impossible.

The Central American country of Honduras, the second-largest country of the famous Northern Triangle, has been mired in poverty and corruption. With a GDP per capita (adjusted for purchasing power parity just short of $2,500,1 the country is the third poorest of Latin America, with only Nicaragua and Haiti being worse off.

Reforms are urgently needed in Honduras. Yet reforms have proven difficult. The country’s ability to introduce urgently needed reforms has been limited, as evidenced by various important economic rankings. For instance, over the last twenty-three years, Honduras has climbed only slightly, and far from meaningfully, on the Heritage Foundation’s Index of Economic Freedom (from a score of 57 out of 100 in 1995 to 60.6 in 2018). On the Global Competitiveness Index, published by the World Economic Forum, Honduras actually fell over the same period, from 53.06 in 2007 (90th on the list) to 52.46 in 2018 (101st).

Honduras is far from being on track to become a developed country. At its current pace,2 it will take 160 years for Honduras to achieve a similar GDP per capita to that of the United States today. The Honduran population can hardly be asked to wait 160 years. To stem migration flows to the north, it is vital that GDP growth in Honduras accelerate from its current levels. Yet there seems to be little hope for a top-down shift in policies and meaningful improvement of Honduras’s present-day institutions.

Nonetheless, the successful implementation of an SEZ could change this pessimistic outlook. As the cases of China, the United Arab Emirates, and Panama suggest, SEZs offer a ray of hope for the poverty-stricken Central American country. Moreover, recent initiatives have emerged to establish a comprehensive type of SEZ called a zone for employment and economic development (ZEDE)3, which has greater flexibility than a typical SEZ.

1.2 Objectives

The aim of this paper is threefold:

1. To briefly review the academic literature on SEZs and assess various SEZs put into practice around the world, looking at both successes and failures

2. To estimate the economic impact of a successful ZEDE in Honduras using different methods

3. To provide a road map for a successful SEZ in Central America

1.3 Definitions 1.3.1 Special economic zones versus other types of free zonesSEZs exist in various forms. As a result, it is important to distinguish between the various types of SEZs, especially in light of recent successes and failures. The World Bank (2008) distinguishes between the following types of special zones:

• Free trade zones (FTZs): duty-free areas to store, warehouse, and re-export goods

• Export processing zones (EPZs): industrial zones geared toward exports

• Single-factory EPZs: a set of privileges and an à la carte legal framework for a single enterprise, without any clearly defined geographical boundaries, akin to early-day special concessions of local governments to foreign enterprises considering investing in their country

• Enterprise zones: smaller zones aimed at providing tax benefits and subsidies to revitalize certain lagging areas

• Specialized zones: zones such as science and technology parks and logistics parks

• Freeports (free economic zones): larger zones that provide multiple incentives and exemptions, permit housing facilities inside the area, and do not distinguish among economic activities taking place inside the area

1. Introduction

1 World Bank (current dollars, 2017).2 Population growth is roughly 2 percent and (real) GDP growth is approximately 4 percent.3 Richard W. Rahn (2015), “Saving Honduras: The Creation of Free Economic Enclaves Promises Much Needed Growth,” Washington Post.

In this study, we attempt to estimate the (potential) impact of a successful ZEDE in Honduras on the material well-being of its citizens, as well as providing a list of policy recommendations to achieve a successful ZEDE. If implemented successfully, a ZEDE could empower a significant group of Hondurans and achieve meaningful GDP growth over the coming decades.

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Among free economic zones, we could highlight the emerging ZEDE adding to the World Bank’s list of special economic zones.

• Zones for employment and economic development: free economic zones with a high level of flexibility and stability, especially with regard to courts, police, and the ability to import best practices in regulatory and legal frameworks from around the world

According to another World Bank (2008) report, SEZs are defined by four characteristics:

1. SEZs are limited by clear yet broad geographical boundaries.

2. SEZs are aimed at and occupied by multiple companies and not by a single company.

3. SEZs are managed by a special zone-management administration without direct interference by local and national governments.

4. SEZs are endowed with an exclusive land-zoning policy, which distinguishes them from other types of industrial parks.

These characteristics differentiate the SEZ from many other economic zones, especially a variety of export-processing zones and single-factory EPZs. We have already mentioned the ZEDE, a type of EPZ. The Honduran government has made strides to introduce the first ZEDEs, which are “more ambitious than typical free-trade zones. . . . [ZEDEs] would be independent jurisdictions with their own laws, courts and police.”4 This type of SEZ thus resembles city-states such as Hong Kong and Singapore more than more-limited SEZs. Hence, ZEDEs encompass more characteristics than SEZs, although the degree of differentiation depends on the specific land-zoning policy and the governance model of the ZEDEs (that is, ZEDEs with an exclusive land-zoning policy and zone management that operates without direct interference by local and national governments).

4 Economist (2017), “Honduras Experiments with Charter Cities.”

SEZs are the subject of an intense debate among economists. Some economists assert that, in practice, SEZs amount to implementing selective fiscal benefits for a few (Moberg 2015), whereas other economists claim SEZs are the key to meaningful economic growth in underdeveloped countries (Amico 2014; Romer 2010). Moreover, there have been both successful SEZs and terrible failures (Moberg 2015). In this section, we try to outline in a systematic way the differences between successful and unsuccessful SEZs.

The number of SEZs has gone up drastically since China increasingly adopted SEZs to promote growth. The majority of SEZs are in developing countries (Carter and Harding 2011) or in economically depressed areas in developed countries (Frick et al. 2015). Institutionalized poverty in the poorest of countries and the inability to change the rules of the game at the national level resulted in developing countries’ increasingly turning toward SEZs as a means of outgrowing poverty by imitating the Chinese economic miracle.

The number of countries that have one or more SEZs has soared in recent years (figure 2).

2. Existing Literature on SEZs

2.1 Overview of SEZs around the WorldAs mentioned before, the most-cited justification of SEZs is the demonstrated fact that many developing countries have been unable to introduce and implement (sufficient) institutional reforms. Instead, such developing countries could resort to SEZs, which would allow them to create economic areas in which legislation could be enacted that promote economic development.

In 1975, just seventy-nine SEZs existed around the globe. Today there are between three thousand and five thousand SEZs (Moberg 2015). (See figure 1.)

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Most SEZs can be found in Asia, although the United States and Latin America are beginning to follow in Asia’s footsteps and are increasingly turning to SEZs (figure 3).

Besides strong evidence from other existing literature, a report from the World Bank (2017) also supports the idea that the benefits of SEZs arise from improvements in competitiveness that translate into higher growth: “(1) SEZs have the power to bring FDI and new businesses to regions and (2) to boost exports; and . . . (3) SEZ-based firms perform better than non-SEZ-based firms” (p. 27). This complements the empirical work by De Haan and Sturm (2000) showing that “more economic freedom fosters economic growth” (p. 239).

Another important potential benefit is spillover effects. As the same World Bank study (2017) summarizes, “Regarding increasing employment and achieving spillovers in the larger region, the literature is inconclusive” (p. 27). In other words, the economic benefits inside SEZs are clear, yet the spillover effects of SEZs to the wider economy remain unclear.

Nonetheless, direct spillover effects do seem to exist at least for nearby areas. A study by the World Bank (2017) has shown that direct spillover effects exist up to a 50 km radius around the SEZ, with the spillover effect being stronger in areas in closer proximity.

In addition, the cases of China and Dubai (e.g., Zeng 2012) show that a successful SEZ can have positive, though indirect, spillover effects, as policies that are clearly working in SEZs are imitated by other political actors in the country or could even promote the establishment of additional SEZs. Put differently, even though the World Bank (2017) might be correct in arguing that positive direct spillover effects are slim and bounded by proximity, indirect spillover effects deserve due consideration. Such indirect spillover effects are, however, more difficult to quantify.

2.2 Potential Benefits of SEZsAs noted, the rationale for SEZs is to accelerate institutional reforms and improve the competitiveness of an (emerging) economy. Many studies have shown the positive impact of SEZs on competitiveness (e.g., Dunning and Zhang 2008; Anastassopoulos 2007; Wilhelms and Witter 1998), measured by a variety of institutional indicators, such as the Global Competitiveness Index, released by the World Economic Forum. SEZs result in significant improvements in the following ways:

• Institutional quality: efficiency of legal framework, government spending, burden of government regulation, property rights, judicial independence, favoritism, diversion of public funds, business costs of crime and violence, and strength of corporate governance

• Quality of infrastructure: the quality, reliability, and availability of ports, roads, airports, electricity, and so on

• Macroeconomic environment: savings, fiscal budgets, and so on

• Goods-market efficiency: principally, tax rates; tax incentives; procedures and time to start a business; trade barriers including tariffs; customs procedures; foreign direct investment (FDI) impediments; and limits to foreign ownership

• Labor-market efficiency: wage flexibility, ease of hiring and firing, labor costs, capacity to attract and retain talent, and female participation in the labor force

• Health, education, and on-the-job training• Availability of financing (ability to issue

securities) and of financial service providers• Availability, reliability, and cost of access to the

internet and phone services• Foreign and domestic market size, business

sophistication, and R&D and innovation

2.3 Factors That Determine the Success of SEZsWe have distilled several determinants of SEZ success from the literature:

• Size and scope: According to a World Bank (2017) study, size matters. SEZs have to span a large-enough geographical area to be successful. Moreover, SEZs

SEZs can circumvent institutional obstacles to reforms that contribute to improvements in competitiveness or any of the above-mentioned categories. Accordingly, SEZs are able to attract more FDI, which in turn leads to greater economic growth.

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should not be limited to technology-oriented (high-tech) industries and activity,5 but should encompass all industries, including non-technological industries (World Bank 2017). Hence, limiting SEZs to certain industries appears ill advised. Broadening the scope avoids the problem of bureaucrats picking winners, whether businesses or industries.

• Proximity and a market-determined location: According to the same World Bank (2017) study, proximity matters as well. SEZs have to be located as near as possible to larger cities, where industry and commerce are already concentrated. Apparently, “large zones in relatively poor areas that are not too far from the largest city, in countries with previous histories of industrialization, and with relatively easy access to developed country markets have performed best” (World Bank 2017, 27). This is in line with Moberg (2015), who argues that because of the knowledge problem it is difficult to select a location for an SEZ, especially if the location is selected by public authorities. Rather, market participants should be responsible for selecting a SEZ-location. In this regard, it appears to make sense to locate SEZs adjacent to larger cities.

• Regulatory independence: It is of great importance to have predictable rules and a sound regulatory framework that promotes wealth creation. To act as liberalized free zones, rather than state-planned industrial parks, SEZs should have the flexibility to establish—without interference by national governments—tax and regulatory policies, as well as their own independent judicial system (Moberg 2015). This should pave the way for improved public policy and, all other things equal, lead to more stable, reliable, and efficient jurisdictions. Further, the SEZs’ administration should be accountable (democratically) through effective and transparent processes. To this end, competition among multiple SEZ administrations has worked especially well in, for instance, the United Arab Emirates (which we will discuss further below). Political interference and abuse is one of the principal causes of failure.

• Creation of private infrastructure: Public investment in infrastructure within the SEZ often suffers from the knowledge problem: officials are unaware of what infrastructure to build, or where. Moreover, there is an incentive problem due to the absence of profits and losses to guide such decisions. A model of private SEZs, which requires private participants to finance investment in infrastructure and facilities, performs better and ultimately fulfills an SEZ’s potential (Moberg 2013). Private participants have monetary incentives to determine what infrastructure is needed, when it is needed, and where it is to be built.

• Efficient land zoning: Having efficient rules for land use and acquisition of land is one of the most important determinants of the success of SEZs (World Bank 2017). In India, for instance, urban land was provided not by the SEZ but by the Indian government, which led to rent-seeking (Moberg 2015). Land use and acquisition should not be regulated by government, but by the zone’s autonomous administration. Land should not be monopolized by the SEZ (that is, SEZs should not make land supply artificially scarce), but should be made amply available to private developers and investors through land auctions and leases. Any land auctions should be conducted in a transparent and public manner, without room for favoritism. This also relates to the size of a SEZ: if the SEZ is too small, it will quickly run into trouble because land is scarce.

The absence of any of these factors could mean introducing an SEZ that is destined to fail. Any resources and time spent on preparing and implementing an SEZ that does not adhere to these factors will go to waste.

5 In fact, the Shenzhen economic zone was initially limited to “technological” enterprises. However, after lackluster re-sults, authorities broadened the definition of what “techno-logical” meant to include virtually any line of business.

2.4 A History of Success and Failure: The Cases of China, the United Arab Emirates, and India 2.4.1 Successful SEZs in ChinaGiven the enormous proliferation of SEZs and the benefits these SEZs are expected to provide, we would expect to see that economies in which SEZs have been widely adopted have prospered. This has been the case in various parts of the world. We will briefly look at the cases of China and India, adding to some of the work previously done by Moberg (2015).

As widely documented, China is perhaps the most important success story. The Chinese national economy is still closed and noncompetitive. The true drivers of Chinese growth have been the country’s SEZs. China began introducing SEZs between 1980 and 1984. Since then, China has opened up its economy by introducing additional SEZs in other parts of the country. In 1980, only four SEZs existed, but by 1984 the number had reached eighteen. Eight years later, in 1992, China had forty-four SEZs.

We can clearly observe the success of Chinese SEZs by comparing the regions that introduced SEZs in the beginning with the regions that introduced SEZs at a later point. The regions that were first in establishing SEZs (in the 1980s) have grown faster than the regions that established SEZs at a later point (in the 1990s or 2000s). In fact, it is the success of the pioneering regions that provided the rationale for Chinese authorities to expand the SEZ model into other regions.

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SEZs in China functioned better and are more prosperous than the areas that were not yet SEZs or only at a later point were granted SEZ status. The success of the early SEZs has led to a gradual expansion of the number of SEZs into other parts of China (Zhen 2012). In addition, because of a multiplier effect, the SEZs have elevated the demand for intermediate products in the rest of the Chinese economy, which has led to some direct positive spillover effects in areas that, in principle, do not have the same ease of doing business as China’s SEZs (Zhen 2012).

Next, we estimated what would have happened to Chinese economic growth if the Maoist regime were still in place (green curve) and if China had broken with the Maoist regime but not introduced SEZs and grown at a similar rate to other moderately low-income countries (orange curve).6 In figure 6, we compared these two scenarios to observed growth in China (light blue curve).

6 Countries with similar levels of income to China’s in 1978.

7 For more details, see Amit Tyagi, “Economic Zones in the Gulf Still Need Careful Nurturing,” National, April 19, 2013. 8 It is especially noteworthy that oil and gas account for a mere 1.5 percent of Dubai’s GDP.

2.4.2 Successful SEZs in the United Arab EmiratesThe case of the United Arab Emirates (UAE) is also illustrative. The UAE has made great strides over recent decades in its economic and trade freedom. Trade (total sum of imports and exports) increased by 400 percent and reached a staggering 156 percent of GDP, with oil representing a mere 20 percent7 (as a comparison, Honduran trade is roughly half, at 77 percent of GDP).

The UAE had the highest growth in the region from 1980 to 2013, increasing GDP tenfold in just over thirty years. Initially, much of the growth came from crude oil,8 but most of the UAE’s recent success has been due to a substantial improvement in its business climate and competitiveness. A large part of this success can be attributed to a rising number of SEZs, especially in Dubai. Many SEZs have been introduced over the years, which has led to ample foreign direct investment.

The SEZs in the UAE have the following characteristics:

• An independent free zone authority (FZA) and a “one-stop shop” bureaucracy, with documentation requirements both in the local language and English

• An independent, internationally regulated regulator and judicial system and common law framework

• 100 percent foreign ownership allowed without the need for local sponsors

• Full import/export tax exemptions, corporate tax exemptions for fifty years, and no personal income taxes

• 100 percent repatriation of capital and profits allowed and no double taxation

• Smoother visa processes for (foreign) employees

The UAE opened its first SEZ in 1985, almost at the same time as China, and has been equally successful. Today, there are over forty-five SEZs in the UAE (figure 7).

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In 2013, Dubai had four of the largest SEZs in the Middle East: Dubai Airport Freezone, Jebel Ali Free Zone, Dubai International Financial Centre and Dubai Multi Commodities Exchange (DMCC). DMCC is the largest of the UAE’s SEZs, ranked by the Financial Times among the world’s top free zones. DMCC houses over 13,700 companies and contributes 10 percent to Dubai’s GDP. In addition, all of Dubai’s SEZs are in close proximity to each other and span relatively large areas (figure 8).

This, of course, does not take into account the initial impact of the expansion of SEZs in the UAE (particularly Dubai) on economic growth. The impact was felt especially at the beginning of the century.

To sum up, the case of the UAE clearly shows how SEZs, which now represent a larger share of the total economy, allow for a more competitive and open economy (as evidenced by its score on the Global Competitiveness Index), which has generated higher growth rates.

By increasing the number of SEZs, the UAE as a whole has enjoyed an increasing score on the World Economic Forum’s Global Competitiveness Index over the past decade (figure 9).

In particular, the UAE has improved drastically its score on property rights, judicial independence, burden of government regulation, strength of investor protection, foreign-market size, number of days and procedures to start a business, and hiring and firing practices, among other components of the Global Competitiveness Index.

As noted above, a large part of this improvement can be attributed to its SEZ policy and the expansion of economic activity within SEZs. For instance, as SEZs in Dubai have their own independent judicial systems, judicial competition improves the efficiency of judicial procedures. Moreover, the burden of customs procedures and trade tariffs is nonexistent in SEZs, lowering the cost of doing business for companies located in these SEZs.

Because of the improvements in competitiveness, the UAE has been able to outperform the average of other Middle Eastern and North African countries in GDP growth from 2011 to 2016 (figure 10).

2.4.3 Failed SEZ InitiativesHowever, not all SEZs have proven equally effective. Many SEZs exist that did not achieve the same levels of growth as China and the UAE experienced.

A clear case in point is India. India could be considered one of the pioneers in implementing SEZs. It introduced its first SEZ in 1965, and it is even said that Chinese authorities drew inspiration from India’s SEZs when they designed their own. In the 1980s, SEZs became increasingly popular, and at the end of the decade six were up and running. Nonetheless, their popularity quickly began to dwindle and by 2000 India had only added one more SEZ in the decade, for a total of seven. A legislative reform in 2005 decentralized and allowed local governments to introduce SEZs. This led to a boom in SEZs. By 2012, already 154 SEZs were operating and another 429 were approved (Tantri 2012).

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Yet the SEZs in India have not performed very well, neither before nor after the 2005 reform. The excessive centralization and bureaucratization in the concession of permits led to rent-seeking on a massive scale and widespread corruption (Moberg 2015).

The SEZs in India are small in size (approximately five thousand hectares), which prevents the necessary economies of scale to develop for certain infrastructural projects. In 2009, of the sixty-three SEZs in India, forty-three covered less than one square kilometer (Mitra 2007).

The decision where to establish new SEZs depended on centralized authorities and not so much on local authorities. Centralized decision-making gave way to a politicization of where to establish new SEZs, with politicians choosing locations for purposes of real estate speculation and self-enrichment. Authorities also used their power to designate areas SEZs, with all the fiscal benefits that such a designation implied, to achieve electoral success (Alkon 2018).

Despite evidence suggesting that Chinese politicians are just as corrupt as their Indian peers, the limited time Indian politicians remain in power reduced incentives to encourage an agenda geared toward long-term economic development (Alkon 2018).

Before 2005, a majority of SEZs in India were single-factory EPZs, in which only one business operates and which, as we have mentioned before, are a recipe for failure.

SEZs function well to the extent that they help make areas more stable with a better business environment. If they do not succeed in making an economy more competitive, SEZs are only useful as a means to reduce the reallocation of economic rents but will prove unable to generate higher economic growth. Empirical studies testify to the fact that Chinese SEZs have been able to generate economic growth because they provoked liberalization and legislative

decentralization, whereas because of their inability to achieve meaningful market reforms Indian SEZs have been unable to bring about economic growth (Leong 2012).

These and other problems have resulted in the Indian SEZs’ having limited economic impact. While the reform of 2005 has solved some of the issues, other challenges continue to exist. The development of SEZs and economic growth in India, even though they are beginning to rebound, are still far removed from the Chinese success case (Alkon 2018).

SEZs only encourage economic growth in a region if they bring market reforms and increases in competitiveness. India, despite being a pioneer in implementing SEZs, has not seen its particular set-up of SEZs lead to improvement in economic and regulatory freedom in comparison to the rest of the economy, and as a result economic growth has not increased (Leong 2012).

Let us analyze the Indian SEZs before and after the 2005 reform. Before 2005, SEZs did not contribute anything to the areas in which they were implemented.

The reform of 2005 removed constraints and decentralized the right to grant licenses to establish and develop SEZs (Moberg 2015). As a result, at the end of 2017 there were over 220 SEZs in India. Therefore, we would expect regions with SEZs to have experienced improvement in their economic performance from 2005 onward compared to non-SEZ regions.

As the implementation of SEZs has been gradual but continuous since 2005, we compare regions that had at least ten SEZs operating before 2010 or more than five hundred hectares of operative SEZs before 2010 with regions that did not have SEZs or had none of meaningful size. Despite the more intensive use of SEZs, many of the problems have persisted over time and we cannot observe a meaningful difference between regions widely covered by SEZs and regions without SEZs.

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In sum, the Chinese economic miracle, largely driven by its SEZs, has not been replicated in India.

SEZs in many other countries have failed. However, many of these failures are actually excluded from our very definition of an SEZ. Colombia (e.g., Medellín), for instance, attempted to develop multiple free zones. However, they are more like industrial parks: geared to a single (high-tech) industry, of limited size, with no residence options within the SEZ, and with no exclusive zoning laws. Hence, these types of special zones do not hold the economic potential of, for instance, China’s SEZs, which have a far broader scope and size.

As we can observe, according to this scenario, GDP per capita within the ZEDE is estimated to reach north of $15,000 per capita in 2040 and $35,000 per capita in 2050.

At this rate, GDP per capita within the Honduran ZEDE also surpasses the world average in 2040 (two decades

3.1 Previous SEZs in HondurasAttempts to establish SEZs in Honduras are not new. Honduras introduced its first SEZ as early as 1976 (at the same time as El Salvador and Jamaica, but before China). More specifically, Honduras created a series of export processing zones. In 1991, Honduras operated nine such zones with a total of forty-nine active businesses, which provided employment to over nineteen thousand workers. Exports from EPZs represented 12 percent of total exports from Honduras (World Bank 1998). The workers of just one of the EPZ’s companies are organized in a labor union. As a result, only 1.5 percent of all workers in Honduras’s EPZs are unionized, compared to an estimated 15 percent of the Honduran labor force outside EPZs,9 roughly ten times less.

3.2 First Method: Forecasted GDP Per Capita with (Historical) Chinese SEZ Growth Rates

The Honduran ZEDEs, if implemented successfully, seem to have the potential to become as successful as the Chinese SEZs. Therefore, we first attempt to approximate the potential economic impact of a successful ZEDE in Honduras by assuming similar trends to the Chinese SEZ case. We estimate Honduran growth both inside and outside the ZEDE.

9 Source: Danish Trade Union Council for International Development Cooperation (Honduras Labour Market Profile 2014).

Nonetheless, these EPZs have not worked out completely as hoped. In 2014, only 2.16 percent of the active population was hired in one of the special zones (ILO 2014). The country as a whole has been lagging in growth over the past decades and, although growing, shows an increasing divergence from developed countries (that is, Honduras is growing slower than developed countries in real per capita terms).

However, initiatives to establish ZEDEs, mentioned earlier, have been undertaken in Honduras. These more comprehensive zones appear to hold a greater promise of success.

3.2.1 Forecast of GDP per capita inside and outside the ZEDE (without spillover effects)With GDP per capita in 2017 as the starting point, we project growth within the ZEDE for twenty years by assuming that growth rates will be identical to the ones observed in China’s SEZs from 1985 to 2017 (10.03 percent annual average growth). The ZEDE is assumed to begin operations in 2020. As a baseline, we use historical (GDP per capita) growth rates for Honduras (light blue curve), and for comparison, growth rates for the world (green curve). (See figure 14.)3. The Potential Impact

of a (Successful) ZEDE in Honduras

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after introducing the ZEDE). In contrast, GDP per capita in Honduras outside the ZEDE continues to diverge from the world average—that is, the world becomes increasingly wealthier than Honduras outside the ZEDE over time.

The introduction of ZEDEs in Honduras could be, of course, less successful than assumed in this projection if Honduran authorities in charge of the ZEDEs are incapable of creating an environment of stability and competitiveness similar to that in the SEZs in China.10 If we assume, to the contrary, a scenario akin to India’s SEZs, then the Honduran ZEDEs will not be able to grow at the projected rate.

10 The recent changes in the Honduran constitution and the introduction of ZEDE legislation appear to align with the best practices that we have outlined in this study.

3.2.2 Forecast of GDP per capita inside and outside the ZEDE (with spillover effects)It is also possible that the implementation of a ZEDE produces spillover effects, benefiting the wider Honduran economy in the same way that growth within Chinese SEZs is having a positive impact on the rest of China. By now, virtually all Chinese regions have some type of SEZ (Zeng 2012), but not all regions introduced their SEZs simultaneously. Hence, we use the Chinese regions that established their SEZs after 2000 to estimate the growth rate of the Honduran economy outside the ZEDE to get a spillover scenario for Honduran GDP per capita. Specifically, we take growth in GDP per capita for Guizhou and Tibet from 1985 to 2000 to project (possible) spillover effects.

As we can observe, there is hardly any difference between the baseline case without spillover effects (historical growth of Honduran GDP per capita) and the case with spillover effects (Chinese non-SEZ per capita GDP growth). According to our estimates, direct spillover effects are expected to be minimal, in line with the literature discussed earlier.

3.2.3 Impact of a Honduran ZEDE on nationwide GDP per capita at 10 percent, 20 percent and 30 percent levels

Given that, according to our projections, per capita GDP growth inside and outside ZEDEs diverge, we can assume various scenarios to observe the impact of a successful ZEDE on nationwide Honduran GDP per capita over time. To do so, we have taken three straightforward scenarios:

1. Honduran ZEDEs comprise 10 percent of total Honduran population

2. Honduran ZEDEs comprise 20 percent of total Honduran population

3. Honduran ZEDEs comprise 30 percent of total Honduran population

This gives us estimates for average Honduran (real) GDP per capita (figure 16).

In the case in which the ZEDE comprises a mere 10 percent of the total economy, nationwide-average GDP per capita (with higher GDP per capita within the ZEDEs making up for lower GDP per capita outside the ZEDEs) still reaches $8,000 after a thirty-year timespan. At the 20 percent level, average GDP per capita becomes significantly higher, at approximately $11,000 after three decades. Last, at a 30 percent level, average GDP per capita would be north of $14,000 within thirty years.

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3.3 Second Method: Forecasted GDP Per Capita with a Dynamic Regression Model

As a second method of estimating the potential impact of a ZEDE in Honduras, we use a dynamic regression model with global competitiveness score as the independent variable.

In line with the reviewed literature, we used the Global Competitiveness Index, published by the World Economic Forum, as a proxy for economic institutional improvement and successful public policy. Honduras, in peacetime, has achieved some, albeit rather weak, GDP growth per capita (as can be observed in the baseline scenario of the first method), mainly because Honduras only marginally improved its Global Competitiveness Index score.

For our base-case scenario, we therefore assume a similar improvement in Honduras’s competitiveness (extrapolating from its past improvement in competitiveness11), and, as a result, see a marginal improvement of GDP per capita over time. It should be noted that, in our base case, Honduran GDP per capita will—again—diverge from rather than converge to Western levels (for instance, GDP per capita in the United States) since Honduras would grow at a slower pace than its developed-country counterparts.12

Moreover, as a means of comparison, we also assume a case in which Honduras’s competitiveness neither improves nor deteriorates.13 In this case, GDP per capita still goes up, albeit marginally. As we will see below, the difference between the past-improvement and no-improvement base cases is negligible for all practical purposes. This shows that at current levels of economic competitiveness, the Honduran economy is heading for sluggish growth and persistent poverty.

We ran a dynamic regression model with global competitiveness score as the predictive variable and GDP per capita (current US$) as the dependent variable. We tried several models to achieve best possible fit, finally including a (one-year) lagging per capita GDP growth as an additional variable (per capita growth of the previous year). Both regressors were significant at the .95 level. Including a lagging variable improved model fit, yet is an assumption that severely limits potential growth in this forecast method, especially when we compare with China’s SEZ-growth. Since

future growth always depends on past growth, this scenario should be viewed as a pessimistic (worst-case) scenario given a successful implementation. Nonetheless, the case of China, for example, has shown that past circumstances and growth do not necessarily predict future growth.

Moreover, it is important to note that because of the limited availability of Global Competitiveness Index observations (limited in years), we have used a simple though effective forecast of Honduran growth based on a few predictors. If we were to include more independent variables, it would be impossible to obtain any statistically significant result. The number of observations needed (minimum sample size) increases drastically to the extent that variables are added to the model. Using the components of the Global Competitiveness Index was, therefore, not an option.

We projected economic growth from 2018 to 2048—that is, thirty years. This is the rough equivalent of one generation. Hence, we aim to show how the Honduran economic reality could change for the better within a single generation’s time if the country introduces a successful ZEDE.

We ran the dynamic regression model four times with different global competitiveness scores from 2018 to 2028 corresponding to our four scenarios:

1. Base case (control) with no improvement in competitiveness (orange curve);

2. Base case (control) with historical improvement in competitiveness (blue curve);

3. Forecast of national Honduran GDP per capita with immediate convergence to the highest observed global competitiveness score (light blue curve);

4. Forecast of GDP per capita within the ZEDE assuming the ZEDE comprises one-third of the total Honduran economy and the rest of the Honduran economy grows at historical rates (green dotted curve).

The difference between the base cases and the ZEDE case is significant: a ZEDE would add almost $2,000 to country-wide GDP per capita (current dollars) over one generation (thirty years) compared to the no-improvement base case. More importantly, GDP within the ZEDEs would reach $14,000 per capita within the same period according to our dynamic regression model, which would be slightly below the average world GDP per capita that we estimated in our first method.

The projections are outlined in figure 17.11 In this case, we used a geometric average of the impro-vement in Honduras’s Global Competitiveness Index score over the period from 2001 to 2017, amounting to an annual increase of 0.012789.12 This is important especially in the light of migration flows: economic divergence rather than convergence could wor-sen migration flows from Honduras toward the US rather than weaken this decades-long trend.13 In this case, Honduras’s score on the Global Competiti-veness Index remains at 3.917 (2017 data) with no further change.

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As evidenced by the chart below, the model fit (data from 2001 to 2017) is high. The orange line shows historical values, whereas the green line shows the predicted values by the model over the same period (figure 18).

The Durbin-Watson statistic is below 2, but not less than 1, which shows that autocorrelation is not a significant issue. This is confirmed by the Ljung-Box statistic, which shows a p-value of less than .95 and points to low autocorrelation in the residuals.

4.1 Opportunities to Change Honduras for the BetterAs our impact study shows, there is significant opportunity for changing Honduras for the better. With a ZEDE covering 20 percent of Honduran GDP, a successful ZEDE initiative would be able to lift (real) GDP per capita to $11,136, more than $7,000 above the base-case scenario’s $4,000 (with no significant improvement in competitiveness, Honduran GDP per capita will equal roughly $4,000 in 2050, which is still lower than today’s GDP per capita in, for instance, its equally poverty-stricken neighbor, Guatemala).

Within a to-be-established Honduran ZEDE, GDP per capita would reach close to $35,000, an incredible improvement in comparison with Honduras’s close and lagging neighbors. This would be approximately eight to nine times better than in the base-case scenario.

Nevertheless, this performance is contingent upon certain factors, which we will briefly discuss in the last two sections.

4.2 Recommendations

Based on the literature, we recommend the following for any initiative establishing a new SEZ:

4. Conclusions

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• Take into account size and proximity: Ideally, the SEZ spans a large area and is adjacent or close to one of its larger (non-SEZ) cities. Not only is this a critical success factor, it will also contribute to better direct spillover effects of the SEZ on the rest of the Honduran economy, such that GDP per capita also improves in nearby non-SEZ areas.

• Give the SEZ administration the power to effectively introduce pro-market reforms: It is very important that no impediments exist to introducing without delay much-needed market reforms, which must translate into better scores and rankings on the twelve pillars of the World Economic Forum’s Global Competitiveness Index, especially those related to goods-market efficiency, labor-market efficiency, and institutional quality.

• Judicial independence: The SEZ should be allowed to establish its own independent judicial system.

• No industry-specific requirements: Any business in any industry should be allowed to participate in the SEZ. Alternatively, if Honduran SEZs are to be industry-specific, a sufficiently large number of SEZs should be permitted, allowing for a wide variety of industries (akin to the case of the UAE), not limited to technological and capital-intensive activities.

• Independent governance model and zone administration: As the literature and the case studies indicate, governments should be unable to degrade the institutional quality of the zone. Flexibility, a sound governance model (which could include competition among zone management teams), and an aligned incentive structure are key factors.

4.3 Risk FactorsIn case any of the above requirements are violated, either by jeopardizing the independence of the SEZ or limiting its ability to operate, it is likely that the projected GDP growth will not be realized. As a consequence, the design of the SEZ should be optimized according to SEZ best practices, as represented by the cases of China and the United Arab Emirates.

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