The Ultimate Startup: Creating a New Country

August 23, 2011

My good friend Auren Hoffman posited that existing nation states would benefit from a little bit of creative destruction and competition to maximize the welfare of their “customers“: http://blog.summation.net/2010/06/the-ultimate-startup-creating-a-new-country.html.

In light of the importance of governance on countries’ economic success I wholeheartedly agree. Bad governance has repeatedly destroyed countries or slowed their growth. We have had many dramatic examples from Mugabe’s destruction of Zimbabwe over the last 15 years to Argentina’s decline from one of the richest countries on a GDP per capita basis to a poor country over the course of the 20th century due to the populist policies of Peron and his successors. The extent to which bad policies and politicians can impact economic outcomes is disheartening and I hope that current American politicians ponder the lessons of history!

While we were brainstorming the idea, we came across an interesting article in the Atlantic by Paul Romer which suggested that poor countries should have foreign run “charter cities” within their borders: http://www.theatlantic.com/magazine/archive/2010/07/the-politically-incorrect-guide-to-ending-poverty/8134/?single_page=true

While the specifics of his idea don’t feel right – I loved the example of Henry the Lion who created a merchant’s Mecca out of Lübeck and transformed it from a backwards city in a failed region with a “bad-governance equilibrium” into a resounding success through light taxation and regulation:

    “Onerous taxes and trade restrictions were ruled out; merchants who settled in Lübeck would be exempt from duties and customs throughout Henry the Lion’s lands, which stretched south as far as Bavaria. The residents of Lübeck were promised fair treatment before the law and an independent mint that would shelter them from confiscatory inflation. With this bill of rights in place, Henry dispatched messengers to Russia, Denmark, Norway, and Sweden. Merchants who liked the sound of his charter were invited to migrate to Lübeck.

    The plan worked. Immigrants soon began arriving in force, and Lübeck became the leading entrepôt for the budding Baltic Sea trade route, which eventually extended as far west as London and Bruges and as far east as Novgorod, in Russia. Hundreds of oaken cogs—ships powered by a single square sail—entered Lübeck’s harbor every year, their hulls bursting with Flemish cloth, Russian fur, and German salt. In less than a century, Lübeck went from a backwater to the most populous and prosperous town in northern Europe. “In medieval urban history there is hardly another example of a success so sudden and so brilliant,” writes the historian Philippe Dollinger.

    Perhaps the only thing more remarkable than Lübeck’s wealth was the influence of its charter. As trade routes lengthened, new cities mushroomed all along the Baltic shore, and rather than develop a legal code from scratch, the next wave of city fathers copied Lübeck’s charter, importing its political and economic liberties. The early imitators included the nearby cities of Rostock and Danzig, but the charter was eventually adopted as far afield as Riga and Tallinn, the capitals of modern Latvia and Estonia. The medieval world had stumbled upon a formula for creating order out of chaos and prosperity amid backwardness. Lübeck ultimately became the seat of the Hanseatic League, an economic alliance of 200 cities that lasted nearly half a millennium.”

Paul Romer’s idea, while intriguing, does not feel right because in our nationalistic world sovereignty and land ownership are explosive issues. Creating cities with new foreign-run rules might solve the trust and credibility problem that many developing countries face as well as attract investments and jobs if people felt the charter would hold. However, it does not seem likely that countries would be willing to lease chunks of their land to foreign powers. The Madagascar example suggests it’s not likely to happen. Besides, Lübeck did not have foreign rule. There is no way Henry the Lion would have let a foreign ruler take charge.

I suspect that a large purchase of land from a poor country in an unpopulated area, most likely in Africa, might work if the new country’s sovereignty could be enforced.

I look forward to seeing some experimentation on the idea in the future!

Non sequitur: One of Paul Romer’s research papers in the early 90s was the inspiration for my junior paper at Princeton: Tariff Policy with Differentiated Products. Mathematically inclined readers wishing to assuage their curiosity can check it out 🙂

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