Special Economic Zones (SEZs) are perhaps the most impactful innovation of the past half-century. Their incredible accent has lifted millions, arguably billions, out of poverty. They have permanently cemented trading networks between countries and ushered in an era of globalization, and they are probably the reason the clothes you are wearing were made in the country they were made in.
Yet, many have never heard of them, and very few could provide a coherent definition of what they are. And let's be clear, there is a good reason why they are hard to explain — they are very weird.
An SEZ, in short, is the adoption of more liberal, or free-market, laws to facilitate growth within a geographic area or zone inside a country while not adopting those rules in the rest of the country. Probably the two most famous examples are Shenzhen in China and the Silicon Oasis in Dubai (see the complete list here). To an extreme — private property on this side of the border | the government owns everything on that side. It's almost like different countries within the same country; again, they are weird.
Why SEZs?
The late 1980s and into the 1990s was an era of unprecedented globalization. As communism collapsed and the Cold War drew to a close, economies opened up, and capital poured from rich countries to poor. The world saw many growth miracles, and many poor countries witnessed historically unparalleled growth rates. And I don’t mean historically unparalleled for that country; I mean historically unapparelled by any country ever!
Yet, these growth rates were not evenly distributed across countries, and, more surprisingly, perhaps, they were very far from evenly distributed within countries. China had the largest miracle, yet it wasn’t so much China growing at nearly 10% year after year; it was SEZs in China where the growth pooled.
When the Iron Curtain fell, there was a realization that many parts of the world fell well behind the west in terms of standards of living. Needless to say, many leaders and citizens asked the same question - how do we catch up? How do we get development and capital to flow here? Well, one successful answer was to try and attract capital via SEZs.
The earliest leader to jump on this trend was China’s Deng Xiaoping. Deng famously said, "It doesn't matter whether a cat is white or black, as long as it catches mice." In other words, capitalism is fine so long as it works. The metaphorical cat was set loose in the many SEZs on China’s eastern coastline, and the mice piled up.
Still, to this day, a little-known fact is that China, which still declares itself a communist country, began to grow due to the establishment of hyper-free market zones. I suppose I am repeating myself, but SEZs are weird, a capitalist oasis in a communist country. Or, in the case of Dubai, a liberal zone in a religious fundamentalist country — very strange!
Special Trust Zones
So given many countries in the world still desperately seek a growth miracle, it would appear easy enough. Just open up SEZs all over. The problem isn’t so simple. The number of successful SEZs is only a small fraction of the attempts to establish them. So what gives? Why have some countries been able to establish them successfully while so many have failed?
There is a long list of factors encouraging capital to flow into a given SEZ. The list includes - ocean ports, an ample supply of cheap but relatively skilled labor, proximity to major markets— the list goes on. With this noted, there is one critical factor. Investors need to trust a government won’t seize and nationalize the business once it is set up. They need to establish trust, and trust isn’t so easy.
Why is trust so hard? In a generic academic sense, this can be described as a problem of time inconsistency. Prior to the investment, a foreign government has the incentive to promise they won’t capture and seize the companies on the ground assets (the factory, machines, roads, ports, etc.) But, once it is built, the incentive changes, and it then makes sense to seize assets. The incentives change with time; they are time inconsistent. Thus, trust is very difficult.
It was a common viewpoint that SEZs were impossible as no corporation, investment fund, or any entity seeking profits would ever trust governments that historically haven’t had the best track record. Track records range from straight-up tyrannical dictatorship (say North Korea) to just run-of-the-mill endemic corruption (I could list many African countries here).
However, they were proven wrong. Similar to the belief that flight was impossible, it wasn’t until the Wright Brothers proved the world wrong that people believed.
The important realization is that while SEZs have had incredible success. They still leave much to be desired. There are still two critical problems, 1) many countries, despite attempts to establish SEZs, have been unable to have investment flow in as companies don’t trust them, 2) even in successful SEZs, companies are very resistant to setting up high-tech intellectual property.
Both these issues stem from the distrust of governments. Simply, many countries can’t provide enough trust to make it worthwhile to invest in them. And, even if trust is established, companies will not take the chance that their intellectual property could be seized by the foreign state. Simply, we can make t-shirts in China, but we are not going to design the next iPhone there. There is enough trust to make things but not enough to set up headquarters.
This is a very rich topic, and I could go on. But, for the sake of this short piece, let's just say SEZs have been an incredible success, but they still leave a lot to be desired. Many countries who seek them can’t attract capital, and even if they do, it is always tenuous. Companies are no fools; they understand the problem of time inconsistency. They commit to a degree but are always looking over their shoulder.
Trustless Zones
Time inconsistency is a human problem; protocols are immune to temptations to renege on prior agreements. They are wonderfully unbias and immutable. Web3 is built on the realization that things that require trust are volatile. Take out the human aspect and make it trustless.
I will propose something I will call Tokenized Economic Zones (TEZs). Assume a token exists and can be a store of value. This, of course, needs to be built in, but for the moment, let's just suppose there is a token that represents governance rights to the TEZ.
To get into a TEZ, you need to buy a governance token. Company A will purchase the token to ensure its profits are secure. Country B will buy the token to attract capital and realize a growth miracle. Lock some of the tokens in a smart contract. If either defect, as determined by an unbias oracle, the other side gets the tokens. Both sides have the incentive to cooperate, and given the unbias nature of the protocol, this incentive won’t change with time.
There are millions of details to be worked out, but the basic structure is sound. While what measures defection and how exactly the smart contract is structured to ensure cooperation is maintained are the nitty gritty that will need to be sorted, at a basic level, a transparent and immutable third party is exactly the solution.
One of the oldest tales in history is that of Odysseus who understood the problem of time inconsistency told through a folk story. Odysseus knew that if he heard the Siren's song, he would steer the ship towards them and peril. Knowing he could not resist, he tied himself to the mast. He solved the problem of time inconsistency; this is exactly what countries and capital want, someone to tie them to the mast. A smart contract is the modern technical way to realize the moral of the fable.
Web3 is Destine for the Global Stage
While these large-scale experiments with blockchain technology might seem futuristic. I will suggest they represent the highest-order impact for immutable, transparent, and uncensorable protocols. International law and trade are always volatile; who polices the police on the world stage? It is inherently an anarchistic environment.
Rules don’t get easier to enforce as you cross borders and cultures; they get harder. But that is just what Web3 is built to handle.