Dubai's Free Zones:
A Scaleable Strategy for Global Free Market Reforms
By Michael Strong, 2010.
The most important policy innovation of the 21st century, in terms of alleviating
global poverty and creating a foundation for a more peaceful world, has been
made by Dubai through its creation of the Dubai International Financial Centre, a
110 acre free zone within Dubai whose commercial transactions are governed by
British Common Law. This is the first instance of a sovereign nation deliberately
committing to applying the laws of another sovereign nation within its
boundaries. Because legal systems largely determine the rate of entrepreneurial
wealth creation around the world, Dubai’s decision to substitute a more effective
system of commercial law, while maintaining traditional Sharia law for criminal
cases, represents a fundamental innovation in wealth creation and poverty
alleviation.
Background
Founded as a fishing village late in the 18th century, the emirate of Dubai was a
weak state dependent upon the Abu Dhabi emirate. In 1833 the Al Maktoum
family seceded from Abu Dhabi, moving to Dubai. The powerful family has
since ruled both the city and emirate of Dubai: the former grew into a major port
and commercial crossroads by the 20th century.
The 1960s witnessed the discovery and development of the emirate’s oil and
natural gas reserves, mostly by British and American companies. The early 1970s
saw the formation of the United Arab Emirates (UAE) followed by foreign direct
investment. And the 1980s were the springboard for the wonder that is Dubai
today. Unlike other Middle East oil kingdoms, Dubai’s then ruler, Maktoum bin
Rashid Al Maktoum, foresaw that it must reinvest its wealth to diversify its
economy and used free zones as part of a business model to create a thriving
Middle East economic magnet. In 2006, the energetic Sheikh Mohammed bin
Rashid Al Maktoum began ruling—driving the original vision to dizzying
heights—pursuing ambitious initiatives including the world’s tallest skyscraper,
building artificial islands, and constructing an indoor ski slope. Some see the city
of two million as a slightly more tasteful version of Las Vegas, but they are
mistaken. According to the CIA, Dubai has the world’s fifth highest gross
domestic product per capita.
Dubai, which was a barren piece of desert soil fifteen years ago, has been among
the most remarkable proofs of the free zone concept. The Jebel Ali Free Zone has
been followed by thirteen additional zones, with another fifteen planned. Dubai
has attracted millions of immigrants to live and work under one of the world’s
most liberal visa and work permit policies. By 2000, Dubai’s economy was worth
$17 billion. By 2005, this had grown to $37 billion, achieved by clocking growth
rates on the order of 17% per year, by far the highest in the world. As of 2002 the
UAE economy as a whole was thirty-six times larger than it was in 1971.1 As of
2007, Dubai expects to triple its economy by 2015.2 Dubai constructs more than
2,000 new buildings per year and is gaining about 300,000 new residents per
year. Klaus Binder, the head of a leading tower crane manufacturer (the type of
crane used to build tall buildings) says that Dubai represents 5-10% of the global
tower crane market. Sheikh Maktoum, the ruler of Dubai and major beneficiary
of Dubai’s explosion of wealth, recently announced a $10 billion philanthropic
gift, the second-largest philanthropic gift in history. While the development
economists may be confused about how to achieve economic growth, the rulers
of Dubai are not.
Dubai International Financial Centre (DIFC)
Dubai was already a spectacular international success due to its existing free
zones when it decided in 2002 to create a global financial hub designed to
compete with London, New York, and Hong Kong. After considering various
approaches to such an ambitious project, Dubai decided that the best strategy for
jump-starting a world-class global financial hub would be to create a legal
environment based on British Common Law. Not only are the world’s top three
financial centers, London, New York, and Hong Kong, based on common law,
but so are number four (Singapore), number eight (Chicago), and number 10
(Sydney).3
For one set of dazzling statistics on Dubai , see “Towards a Bright Future,”
http://www.adcci.gov.ae/public/media/Magazines/Dec.2002/towards/html.
It is noteworthy that despite this dynamism within the free zones, outside the
free zones, such as in agricultural sectors, there is a lack of economic freedom
and consequent economic stagnation – yet another case study in the efficacy of
economic freedom.
2
Reuters and Rob Corder, “Dubai Economy set to treble by 2015,” Arabian
Business News.com, 3 February 2007.
1
3
http://images.businessweek.com/ss/08/03/0305_financial_centers/index_01.ht
m (Zurich is 5, Frankfurt 6, Geneva 7, and Tokyo 9)
Dubai hired Sir Anthony Evans to be the chief justice of the newly-established
DIFC court. He had previously served as the senior commercial judge in
London. His deputy is Michael Hwang, a former commercial judge in
Singapore. Although British Common Law, administered by judges trained in
common law, was to serve as the legal foundation of the DIFC, from early on the
judges realized that it would be important to clarify the relationship between
legal adjudication on commercial issues within the DIFC and legal issues that
might arise in conjunction with the civil code of the UAE at large (many business
entities in the DIFC were likely to conduct at least some business with entities
outside the DIFC) and with Sharia criminal law.
As a consequence, the DIFC has been exceptionally pro-active in communicating
its evolving legal framework to the business community. For example, in
December 2006, two years after formally launching the DIFC, the leaders of the
DIFC announced in a press release that draft rules of court would be available for
public consultation,
His Excellency Dr Omar Bin Sulaiman, Governor of the DIFC said:
"The publication of the Rules marks a crucial stage in the
development of the DIFC Courts. Furthermore, this action
highlights the transparency and integrity of the DIFC and enables
the wider community to participate in the evolution of the DIFC's
legal system, establishing itself as a jurisdiction with the highest
international standards and best legal practices."
Sir Anthony Evans, Chief Justice of the DIFC Courts commented:
"With the draft Rules of Court, we have endeavoured to balance
ease of use with practical guidance for the practitioners in the DIFC
Courts who come from diverse legal backgrounds. We believe
these Rules contain provisions that will be familiar to local and
global practitioners and their clients, and will represent
international best practice across the board. I would warmly
encourage all interested parties to consider the draft Rules of Court
and provide input as they see necessary."
The draft Rules of Court are modelled on the English Civil
Procedure Rules ("CPR") as at October 2006 and the English
Admiralty and Commercial Court Guide, 6th Edition. The CPR
were a product of wide consultation and an examination of
international best practice. The Guide aims to provide practical
guidance for users of a court that has been serving the international
business community for over 110 years.4
What is most striking about this press release is the extent to which the tone is
more similar to that of a for-profit corporation advertising its products’
excellence and the company’s commitment to customer service rather than the
usual tone of legislative fiat based on monopolistic legal authority. The leaders
of the DIFC know that they are competing for global financial transactions, and
they are out to win. The DIFC has continued to maintain a commitment to trustbuilding transparency in articulating how legal decisions will be made, most
recently refining the boundary between commercial law (based on common law)
and criminal law (based on Sharia law).5
By December 2008, more than 750 firms had registered in the DIFC.6 Private
sector investors had invested more than $18 billion in infrastructure by fall 2008.7
Thus 110 acres of land in the DIFC attracted approximately as much direct
foreign investment in four years as did all of Sub-Saharan Africa, exclusive of
South Africa, during the same period.8
Poverty Today is Caused by Legal Frameworks that Do Not Provide Adequate
Economic Freedom
In the past twenty years, development economists have gradually come to a
consensus that the legal institutions of a nation-state are a significant
determinant of economic growth.9 More controversially, other development
economists and legal scholars have made the case that common law nations,
4
http://difccourts.complinet.com/en/display/display_main.html?rbid=2725&ele
ment_id=3589
5
http://www.gulfnews.com/Business/Banking_and_Finance/10261317.html
6
http://www.albawaba.com/en/countries/UAE/237781
7
http://qn.som.yale.edu/article.php?issue_id=10&article_id=146
8
Estimated from data contained in
http://www.stratfor.com/analysis/africa_constraints_fdi_sub_sahara,
http://www.southafrica.info/business/investing/fdireport2006.htm,
http://tradeafrica.blogspot.com/2008/09/africas-fdi-inflows-reach-record53.html
9
Douglass North, Institutions, Institutional Change, and Economic Performance,
Cambridge University Press, 1991, is a good place to start in exploring this literature.
typically former British colonies, outperform civil law nations because British
common law provides a more hospitable environment for business.10
Unfortunately both of these findings have led to a discouraging consensus
regarding economic development prospects for many nations, insofar as legal
systems are not easy to change. Although the World Bank and others are
spending a tremendous amount in training lawyers and judges around the
world, it is not clear what impact such training is having and, under the most
optimistic scenarios, it could take decades for legal systems to improve
significantly by means of such training. Moreover, based on both traditional
public choice theory as well as Douglass North’s newer conception of a “natural
state,” there are reasons to believe that established elites in developing nations
will systematically undermine any legal reforms that would undermine their
existing rent-seeking privileges.11
It is in this context that Dubai’s decision to create a legal entity subject to British
Common Law within the boundaries of the emirate of Dubai and the nation-state
of the United Arab Emirates, a “country within a country,” is a striking
precedent with potentially enormous global implications. Once decision-makers
(be they political leaders, key influencers, or the electorates) in other nationstates realize that prosperity can be achieved by means of the credible
establishment of existing world-class legal systems within geographicallybounded free zones, we may see a gold rush towards prosperity that eliminates
global poverty more rapidly than anything previously imagined.
While political elites in many nations will continue to resist nationwide economic
liberalization, geographically-limited free zones provide a strategic end-run that
in some cases will allow forward-thinking subsets of such elites to create islands
of prosperity that subsequently result in a greater nationwide economic
liberalization. And as opinion leaders and the poor from around the world
realize that prosperity for all may be obtained by means of a relatively simple
administrative decision, implemented with integrity, there will be tremendous
pressure to allow such islands of prosperity to come into existence around the
world.
10
Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1998.
"Law and Finance," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages
1113-1155, December is the contemporary article that stimulated a controversy around this issue,
though Hayek articulated an abstract analysis that came to a similar conclusion based on
somewhat different grounds, Friedrich A. Hayek, Law, Legislation and Liberty: A New
Statement of the Liberal Principles of Justice and Political Economy 94 (1973).
11
North, Douglass C., Wallis, John Joseph and Weingast, Barry R.,A Conceptual
Framework for Interpreting Recorded Human History(December 2006). NBER Working
Paper No. W12795. Available at SSRN: http://ssrn.com/abstract=953360
The Role of Free Zones in Wealth Creation Around the World
The rise of the four Asian Tigers: Hong Kong, Singapore, Taiwan, and South
Korea, each of which moved from poor to rich in the period from 1960-1990, was
a key element in persuading many observers that entrepreneurial capitalism was
more effective than socialism at alleviating poverty. Of the four, Taiwan and
South Korea grew their economies by means of export processing zones offering
tax holidays and removal of customs duties. 12 13 Hong Kong and Singapore each
were based on free port policies of removing tax and trade barriers. In the Fraser
Institute’s Economic Freedom of the World Index, Hong Kong and Singapore
have been ranked as the most economically free nations in the world every year
since the index was created. Hong Kong is now one of the wealthiest nations on
earth and is the model for China’s extraordinary growth through special
economic zones.14 Singapore is among the wealthiest, with a higher per capita
income than Japan or Germany, and Singapore has now been hired by China as a
free zone developer as well.
Less well known is Mauritius, an island off the coast of Africa that experienced
average real GDP (PPP) growth of 5.9% from 1973 to 1999 through the creation of
economic processing zones, leading to average per capita incomes greater than
$12,000 per annum, higher than Chile, South Africa, or Russia.15 In addition to
See Jean-Paul Gauthier, “Free Zones: Performance, Lessons Learned, and
Implications for Zone Development,” paper prepared for the Foreign Investment
Advisory Service (FIAS) conference “An Enabling Environment and Economic
Zones for Private Sector Development in Bangladesh,” 14-15 December 2004, for
a comparison of the differential free zone impact on the economic development
of South Korea vs. the Dominican Republic. Free zones are a neglected field
within academic economic development studies.
13
It is important to note that as of 1970, Taiwan had more economic freedom
than all but four Sub-Saharan African nations today (Botswana, Mauritius,
Zambia, and South Africa) and that today it has more economic freedom than
any African nation. Although South Korea had relatively little economic
freedom in 1970, today Botswana is the only sub-Saharan African nation with a
higher rank.
14
See William Overholt, The Rise of China, for Hong Kong’s role in jumpstarting China, leading with Shenzhen. Twenty-five years ago Shenzhen was a
small fishing village; now Shenzhen alone has a GDP higher than any subSaharan nation except South Africa and Nigeria (most of which is due to oil).
15
Eustace Davie, “Mauritius: Where They Don’t Kill the Geese that Lay the
Golden Eggs,” originially published in Moneyweb SouthAfrica, taken from the
Mercatus Center website, May 6, 2007.
12
the examples listed above, zones have played a leading role in the broader
economic liberalization of Ireland and Mexico and may yet stimulate greater
economic liberalization in India.
Despite these facts, zones have been largely neglected in the literature on
economic development. A leading text on Economic Development, by Michael
Todaro and Stephen Smith, mentions zones in passing in the course of its 861
pages, citing the fact that zones contributed to economic development in China
and South Korea.16 Gerald Meier and James Rauch’s Leading Issues in Economic
Development does slightly better, mentioning zones five times in 602 pages,
citing China, Malaysia, and Mauritius in particular, Asia in general, and even
identifying zones as a general policy option for economic development.17 Jeffrey
Sachs’ best seller The End of Poverty mentions “Export Processing Zones” as one
of ten effective, scaleable approaches to poverty alleviation, and the only one
which is a policy option (seven are public health interventions, plus Borlaug’s
Green Revolution and Grameen Phone, a for-profit company). On the other
hand, Elhanan Helpman’s comprehensive survey of the academic literature on
economic growth, The Mystery of Economic Growth,” doesn’t mention zones
even once, nor does Amartya Sen’s “Development as Freedom,” nor does Barro
and Sala-i-Martin’s “Economic Growth,” nor does William Easterly’s “The
Elusive Quest for Growth.”18 Easterly, to his credit, acknowledged in a meeting
convened on free zones, that development economists had pretty much
neglected their study. The U.N. Commission on Growth Report, issued May 22,
2008, led by Nobel Laureate Michael Spence, does mention Special Economic
Zones as a growth strategy in a couple of paragraphs out of its 180 pages.19
There have also been numerous free zones (or “Special Economic Zones” or
“Export Processing Zones”) which have failed to succeed or which have failed to
stimulate broader economic liberalization or economic activity. Jamil Tahir, an
economist working for the Organization of Arab Petroleum Exporting Countries,
OAPEC, analyzed why some Arab free zones were effective and others were not.
He studied more than 27 free zones in Lebanon, Syria, Morocco, Egypt, Jordan,
Tunisia, and the UAE and concluded that the three categories of reasons
determined why some zones failed to succeed:
1. Administrative
16
Michael Todaro and Stephen Smith, Economic Development, Addison Wesley, 2008.
Gerald Meier and James Rauch, Leading Issues in Economic Development, Oxford
University Press, 2005.
18
Helpman, Belknap Press, 2004, Sen Anchor 2000, Barro and Sala-i-Martin MIT Press
2003, Easterly MIT Press 2002.
19
See The Growth Report: Strategies for Sustained Growth and Inclusive Development,
The World Bank Group, July 2008, pgs. 47-48.
17
2. Marketing
3. Infrastructure
Of these, Tahir acknowledged that infrastructure issues were rarely an issue
among Arab free zones. He provides useful marketing advice, most of which is
routine for for-profit enterprises but which may be useful for governmentmanaged free zones.
Of most interest to our focus is his analysis of “administrative” obstacles to free
zone success:
(1) Excessive red tape and bureaucracy where investors have to deal with
several departments to obtain licenses or approvals. The process is
tedious and lengthy.
(2) Lack of actual autonomy of Free Zones even though they are accorded,
by law, financial and administrative authority. In Jordan and Egypt, for
example, the budget requires approval by a minister or council of
ministers in addition to the board of directors of the Free Zone.
(3) Unexpected changes in laws and regulations that continuously
confuse investors.
(4) Conflict and overlap of laws and procedures related to Free Zones as
well as to customs.20
All of these “administrative” obstacles represent, in reality, an absence of
adequate and effective economic freedom within the zone. Tahir cites Dubai’s
Jebel Ali Free Zone as the most effective, and most economically free, of the Arab
free zones.
The terms “free zone,” “special economic zone,” and “export processing zone”
have been used to describe many thousands of different entities which often
share only one common characteristic: A geographically-restricted set of tax or
regulatory policies that differ from those of the surrounding jurisdiction. In
order to ensure that free zones consistently have the positive economic impacts
that they sometimes have had, it is critical that the substance of those tax or
regulatory policies be more clearly defined. In the worst case scenarios, “free
zones” have merely served as an excuse for government cronies to obtain tax
20
Tahir, Jamil,An Assessment of Free Economic Zones in Arab Countries: Performance
& Main Features(1999). Working Paper No. 9926. Available at SSRN:
http://ssrn.com/abstract=216991, pg. 26.
breaks from the government. In the best case scenarios, such as the Dubai free
zones, and especially the DIFC, “free zones” offer a fundamentally different and
often profoundly superior legal environment for commercial activity.
In order to understand more clearly the role of economic freedom in enabling
commercial activity, it is helpful to go into a brief survey of the documented role
of economic freedom in increasing economic growth. Because hitherto data has
only been collected at the nation-state level, we have no data on the role of
economic freedom in enabling economic growth within free zones. That said,
most observers acknowledge that, in line with Jamil Tahir’s analysis, the most
successful free zones provide business with significantly more economic freedom
than is the case in the surrounding jurisdiction. Indeed, Robert Lawson, one of
the authors of the Fraser Institute Freedom of the World Index, acknowledges
that due to Special Economic Zones “China literally has the most free and least
free economies within its borders at the same time” and that the Freedom of the
World methodology, which is based on nation-state data, fails to take this
phenomenon into account.21
Economic Freedom and Economic Prosperity
Gurcharan Das, the poverty guru from India has estimated that at rates of
economic growth in India under socialism, it would have taken until 2300 for
India to reach a U.S. standard of living. In the capitalist growth rates
experienced by India after the economic liberalizations of the early 1990s, India is
now expected to reach a U.S. standard of living around 2050. Only economic
freedom, by accelerating economic growth, has the power to bring more than a
billion people out of poverty 250 years faster than would otherwise have
occurred. It is in recognition of the unique ability of economic growth to
alleviate, or eliminate, poverty that Nobel Laureate Robert Lucas has said “Once
you start to think about economic growth, it is hard to think about anything
else.”
“Economic development” efforts, such as Jeffrey Sachs’ Millennium Villages,
which do not focus on creating the conditions for entrepreneurial capitalism,
may alleviate some immediate suffering but should not be regarded as
improving living standards to any significant extent. Entrepreneurial capitalism
is the only means of alleviating poverty as well as the only means for creating a
lasting foundation for world peace. No country on earth has raised its peoples’
standard of living without entrepreneurial capitalism having played a significant
role.
21
Personal communication, 8/28/07
In the 1980s Michael Walker of the Fraser Institute gathered Milton Friedman,
Gary Becker, and other prominent free market economists together to create a
formal measure of economic freedom. The result was the Fraser Index of the
Economic Freedom of the World which today uses 38 distinct third party,
objective data sources to measure the economic freedom of most of the nations
on earth (a few are not included due to lack of adequate data).22 Fraser
measures economic freedom using publicly available data in five categories:23
1.
2.
3.
4.
5.
Size of Government: Expenditures, Taxes, and Enterprises
Legal Structure and Security of Property Rights
Access to Sound Money
Freedom to Trade Internationally
Regulation of Credit, Labor, and Business
There are two key findings:
1. Per capita GDP is highly correlated with economic freedom: rich countries are
free, poor ones are not.
2. An increase in economic freedom correlates with increased rates of economic
growth.24
The result: Any nation that continues to increase its Fraser ranking over a
twenty year period will almost certainly experience increased economic growth.
According to several econometric estimates, a one point increase in economic
See Gwartney and Lawson, The Fraser Institute Economic Freedom of the
World: 2006 Annual Report.
23
Because this index includes data going back to 1970 for some countries, and
because it is based on publicly available data sources, the Fraser Index is more
frequently used for scholarly research than is the better known Wall Street
Journal/Heritage Economic Freedom Index (though the two are highly
correlated). As a consequence, there is a large and growing set of empirical
evidence of the consequences of economic freedom on economic growth.
24
For a review of the literature on economic freedom from a skeptical European
perspective that nonetheless concedes the evidence that economic freedom
increases rates of economic growth, see Jakob de Haan, Susanna Lundstrom, and
Jan-Egbert Sturm, “Market oriented institutions and policies and economic
growth: A critical survey,” Thurgauer Wirtshaftsinstitut Research Paper Series
No. 5, March 2005. See also See Gwartney, Holcombe, and Lawson, “Institutions
and the Impact of Investment on Growth,” Kyklos Volume 59 Issue 2 pages 255273, May 2006.
22
freedom, on the Fraser Institute rankings, results in 1% or greater increase in
rates of economic growth. 25
The following diagram, from William Easterly’s article “Freedom vs.
Collectivism in Foreign Aid,” in the Fraser Institute Economic Freedom of the
World: 2006 Annual Report, shows the correlation between per-capita income and
economic freedom:
Few correlations in the social sciences are as clear-cut as is the correlation
between economic freedom and prosperity.26
Eight of the top ten ranked nations on the index are common law nations, Hong
Kong, Singapore, New Zealand, United Kingdom, Canada, Australia, United
States, and Ireland. 22 of the 30 lowest ranking nations are African. 27
de Haan, Lundstrom, and Sturm, op. cit..
See James Gwartney and Robert Lawson, with William Easterly, Economic
Freedom of the World: 2006 Annual Report, pg. 33.
25
26
These abstract economic freedom ratings have very concrete real world
consequences. The Peruvian economist Hernando de Soto and his team have
worked in dozens of poor countries estimating how long it takes to open up a
legal business.28 They have discovered that in poor nations it takes between one
and two years, working full-time going from government office to government
office, in order to open up a legal business.
Only elites can afford to go through these labyrinthian procedures – or, more
likely, to bribe officials so that they don’t have to submit to such nonsense.
Indeed, over-regulation is a primary cause of developing world corruption. The
consequence of such over-regulation is that when the poor do become
entrepreneurs, they have no property rights, no secure contracts, and no
insurance, none of the standard protections that every business person in the
developed world takes for granted. Their opportunities as business people are
severely constrained by the absence of an accessible legal system.29 One recent
study estimates that moving from the lowest quartile of business regulations to
the highest quartile implies a 2.3 percentage point increase in annual economic
growth – depending on the size of the nation; this translates into millions, tens of
millions, or hundreds of millions of additional people being brought out of
poverty each year.30
Free Zones with Custom Legal Systems
Milton Friedman was among the earliest and most persistent celebrators of Hong
Kong as exemplar of economic freedom. As Friedman recognized many decades
ago, Hong Kong provides a policy model for eliminating poverty worldwide – a
far more effective policy model than Millennium Villages. And yet the global
This and all rankings are taken from See James Gwartney and Robert Lawson,
Economic Freedom of the World: 2008 Annual Report.
28
See Hernando De Soto, The Mystery of Capital: Why Capitalism Triumphs in
the West and Fails Everywhere Else.
29
The World Bank Private Sector Development website has an entire section
devoted to papers researching various dimensions of this issue,
http://rru.worldbank.org/PapersLinks/Reducing-Administrative-RegulatoryBarriers/. See also the World Bank “Doing Business” rankings and website,
http://www.doingbusiness.org/.
30
Simeon Djankova, Caralee McLiesha, and Rita Maria, “Regulation and
Growth,” World Bank, available online 24 July 2006.
27
development community has scarcely noted the power of Free Cities to alleviate,
or eliminate, poverty. 31
Of the five elements of economic freedom as defined by The Fraser Institute,
three may be encouraged, or coerced, somewhat effectively through the efforts of
international organizations such as the World Bank and IMF. The Washington
Consensus, of which Sachs was a leading figure in policy implementation,
coerced many poor nations to privatize industries and thereby reduce the size of
their governments, to stabilize their money supplies to some extent, and to open
their borders to global trade. The Washington Consensus has a mixed record
because these initiatives alone are only of uncertain outcome in initiating
economic growth.32
But the two most important economic freedoms, secure property rights and
streamlined regulatory environment, are most difficult to impose from the
outside or to create from the inside.33 Although the Washington Consensus was
able to force a few specific deregulation acts, it was not able to cut through the
thousands of choking regulations that are, in fact, responsible for the lack of
enterprise in many developing nations. Washington Consensus policies were
even less successful at ensuring property rights and rule of law, the most serious
problem of all in the developing world.
Insofar as it has become clear that these “institutions” are critical for economic
development, it has also become depressingly clear that it is difficult to create
sound institutions within those countries in which they are lacking. Those legal
institutions that have allowed Western nations to create extraordinary wealth
See Ken Hagerty and Theodore Malloch, “Free Cities,” Weekly Standard, July
18, 2007 for a bold proposal, modeled on Hong Kong, for the U.S. to create free
cities to alleviate illegal immigration.
32
More recently, the U.S. State Department has created the Millennium
Challenge Account as a carrot-based approach to encouraging positive reforms.
It remains to be seen how effective this approach will be.
31
Mogens K. Justesen, “The Effect of Economic Freedom on Growth: Evidence
on causality from a panel of countries 1970-2000” concludes that “Legal Structure
and Security of Property Rights” and “Regulation of Credit, Labor, and
Business” provide the most robust relationship to increasing rates of economic
growth. Justesen’s conclusions from extensive analyses of data happen to reflect
the independently derived conclusions of Hernando De Soto See Hernando De
Soto The Mystery of Capital: Why Capitalism Triumphs in the West and Fails
Everywhere Else.
33
took hundreds of years to evolve. The carrots and sticks of the World Bank and
IMF are singularly unsuited to support the growth of better legal systems in
those nations in which they are most urgently needed. What to do?
Dubai’s Common Law Innovation in the DIFC as Scaleable Strategy for
Global Poverty Alleviation
Earlier we flippantly remarked “While the development economists may be
confused about how to achieve economic growth, the rulers of Dubai are not.” It
is time to clarify the sense in which this remark is true.
It is noteworthy that from the time of Adam Smith through the late 19th century
most economists in the Anglo-American world believed that economic freedom
was the foundation of wealth creation. Smith’s most famous book was titled,
after all, An Inquiry into the Nature and Causes of the Wealth of Nations. In the
late 19th century, when capitalism was being attacked, William Graham Sumner
concisely summarized the foundations of this system,
“Some men have been found to denounce and deride the modern
system—what they call the capitalist system. The modern system is
based on liberty, on contract, and on private property (Sumner
1883, 64).”
And subsequently these simple foundations of wealth creation were ridiculed,
and then forgotten, throughout most of the 20th century by the world’s leading
scholars. Many of the world’s scholars became Marxists, a set of ideas that were
catastrophically wrong-headed. Others became development economists
following the neo-classical theories of Paul Samuelson, Robert Solow, and others
who focused on the role of capital investment while largely ignoring the role of
“liberty, contract, and private property.” This neo-classical blindness led to
massive investments of foreign aid (aka “capital investment”) that has mostly
failed to result in economic development. Only with the work of Hernando de
Soto, Elena Panaritis, and Douglass North, and then others, have institutions
been taken more seriously.
And, as mentioned above, although most economists now openly acknowledge
the role of institutions in promoting economic growth, the notion that Common
Law institutions provide a superior foundation for supporting economic growth
remains controversial, with hundreds of academic articles being published each
year arguing for, and against, the notion that Common Law countries have some
advantage.
And while nearly two billion people remain trapped in nations that have not yet
found a way to achieve growth, the academic debates continue. Because of the
complexity of the data, we can expect the debates to go on for decades to come,
much as the debates over the relative merits of capitalism vs. communism
continued vigorously from the 19th century until 1991, when events overtook the
academy. It is worth remembering in this context that Paul Samuelson's
Principles of Economics 13th edition, published in 1989, claimed “the Soviet
economy is proof that, contrary to what many skeptics had earlier believed, a
socialist command economy can function and even thrive.”34 Samuelson's
economics textbooks, selling more than 4 million copies, represented the apex of
“expert judgment” in economics throughout the 50s, 60s, 70s, and 80s.
Meanwhile the entrepreneurial leadership of Dubai has not waited for academic
consensus. In creating the DIFC based on common law, they made a strategic
business decision that a common law financial free zone, adjudicated by
experienced common law judges, would attract capital more quickly than would
the existing foundation of Sharia law and civil law that operates elsewhere in the
UAE. They violated all existing norms of national sovereignty by implementing
a foreign legal system within their sovereign boundaries. And $18 billion worth
of private investment has concluded that they have made a wise decision.
Economic Zones World (formerly Jafza International) of Dubai is arguably the
world’s leading developer of logistics, business parks, and free zones around the
world. They already have operations in Morocco, Djibouti, and Malaysia. They
recently signed a contract with Senegal to create an $800 million free zone, the
first of its kind in continental Africa, while Dubai Ports, another affiliate, is
investing $600 million in an expansion of an existing port in Senegal.
DIFC is very much an experiment, albeit a highly successful one. The judges are
still working on integrating the legal system of the DIFC with the surrounding
jurisdictions, as well as expanding the legal system of the DIFC to optimize it as a
global financial center. The perspective of the DIFC is that the legal system of the
free zone is an operating system for financial capitalism that can and should be
continuously improved so that it continues to attract an increasing proportion of
the world’s financial markets. To create a competitor for London, New York,
and Hong Kong over the course of a few years is one of the most ambitious
entrepreneurial endeavors in history.
34
See Mark Skousen's excellent analysis of the history of Samuelson's textbooks, "The
Perseverance of Paul Samuelson's Economics,"
http://www.mskousen.com/Books/Articles/perserverance.html.
But if the DIFC experiment in optimizing a legal system within the boundaries of
a nation-state becomes a precedent for the expanding operations of the Dubai
World Group around the world, if Dubai World Group becomes a leading global
vendor of both physical and legal infrastructure, then the achievement of
creating a new global financial hub will be but the tip of the iceburg. In a world
in which the greatest cause of poverty is poor legal infrastructure, any entity that
can create turn-key world-class legal environments within sovereign nations
around the world will have created a profitable business with the potential to
eliminate global poverty orders of magnitude greater than anything we’ve ever
seen before.
Often local real estate developers double or triple their investment by lobbying
for a local zoning change from, say, residential use to commercial use. Hundreds
of millions of dollars are literally “created” instantaneously by means of a change
in zoning.
Similarly, the best free zones have increased land values ten-fold, a hundredfold, or more. The creation of free zones in Dubai has transformed land that was
worth almost nothing thirty years ago to some of the most valuable real estate on
the planet.
There are about 13 million hectares of land on the planet, the vast majority of
which is located in regimes with abysmally poor property rights, rule of law, and
little economic freedom. With respect to information technology, many are
concerned about how the “digital divide” is leaving billions of people behind.
We should be even more concerned by the “legal divide” in which some of us
live in “gated communities” with relatively high quality legal systems that
support wealth creation and thereby attract investment capital, whereas at least
two billion people live in nation-states that are more like prisons, where the legal
environment inhibits both indigenous entrepreneurship and foreign direct
investment. Unless we provide these two billion people with access to a worldclass legal environments, their nations will remain breeding grounds for
terrorism, civil wars, epidemic diseases, and environmental catastrophes for
decades to come.35
Through the common law regime of the DIFC, Dubai has established a new
precedent, according to which the identification of nation-state and legal regime
is no longer taken for granted. Based on this precedent, Dubai World Group and
For an original proposal to create a free zone with a high quality legal system
in a stateless region that is integrated with local customary law, see Michael Van
Notten, The Law of the Somalis, Red Sea Press, 2005, esp. Chap. 15 and
Appendix C.
35
their competitors may now install world-class legal institutions anywhere where
they are welcomed. And as future historians of the 21st century look back, they
will recognize the precedent set by the DIFC as the beginning of the end of
poverty.