Prosperity Must Be a Cornerstone of Fostering Honduran Democracy
This commentary is one of two publications presenting differing viewpoints on the Zones for Employment and Economic Development (ZEDEs).
As a friend of this author once said, “you can’t eat sovereignty.” And yet that is exactly what Honduran president Xiomara Castro proposes to do. The ruling Liberty and Refoundation (Libre) Party is on the verge of voting to dissolve a type of special economic zone (SEZ) in the country, under the spurious argument that such zones violate the nation’s sovereignty, which must be reclaimed in the name of the Honduran people. In a commentary published in tandem to this piece, Mark Schneider and Aaron Schneider have amplified this message and encouraged U.S. policymakers to stand back as the Honduran Congress threatens to essentially expropriate hundreds of millions of dollars in U.S.-based foreign direct investment.
In 2013, Honduras adopted a constitutional amendment establishing Zones for Employment and Economic Development (ZEDEs), marking the beginning of that country’s experiment with a new and potentially powerful tool to catalyze economic growth. These zones would represent a form of SEZ marked by expanded regulatory freedoms for their operators, allowing tailor-made laws and regulations to promote business development and trade. In the decade since, the ZEDEs have become a point of contention, culminating in President Castro’s 2021 campaign and now the efforts to repeal the enabling legislation. Critics of the zones continue to reiterate some of these tired and disproven attacks on ZEDEs—all without offering a credible path forward for resolving the inevitable investor disputes or even suggesting an alternative arrangement that could spur much-needed economic growth needed to address the root causes of migration.
Debate over the ZEDEs has been colored by two interrelated facts. First, their association with former president Juan Orlando Hernández seems to have tarnished the zones with something akin to “original sin.” Today, Hernández faces trial in the United States on drug and weapons smuggling charges, leaving behind a painful legacy of corruption and abuse of power. The ZEDEs have been painted by critics as pet projects of the disgraced former president.
Second, detractors tend to compare ZEDEs to a previous 2011 law permitting Special Development Regions (REDs). Further tangling discourse on the matter has been the similarities between the 2013 ZEDEs and 2011 REDs laws, both of which sought to establish special jurisdictions to promote economic growth in Honduras. However, the Honduran Supreme Court struck down the REDs law as unconstitutional, prompting lawmakers to incorporate a number of provisions aimed at enshrining respect for Honduran sovereignty into the ZEDE law. The 2013 ZEDE Organic Law requires all zones to be subordinate to Honduran law “in all topics related to sovereignty, application of justice, national defense, foreign relations, electoral matters, and issuance of identification documents and passports,” (author’s translation). Yet, detractors continue to peddle the idea that ZEDEs are a violation of the inviolable—sovereignty—that must be rectified by dissolving them.
With the future of the zones in question and now becoming the subject of a nearly $11 billion dollar claim against the government of Honduras, a grounded understanding of ZEDE operations, their economic potential, and the consequences of their repeal is vital. For over one year, the CSIS Americas Program has filled the dearth of analysis in the D.C. policy ecosystem on SEZs in Central America, and the ZEDEs in particular, assessing their advantages and disadvantages with a series of rigorous, scholarly projects that filled this important vacuum. The results of this analysis point to a number of pragmatic arguments for the persistence of ZEDEs, albeit with certain areas for reform the program has outlined also being a possibility. To date, the ZEDEs have proven effective in attracting investment and generating employment, serving key U.S. and Honduran policy objectives to nearshore supply chains, and contributing to broader geopolitical objectives vis-à-vis great power competition in the hemisphere. Finally, even if the benefits of the ZEDEs prove less than their potential, simply terminating the zones represents a lose-lose scenario for investors and the Castro government alike.
A World Bank assessment of SEZs around the world concluded that zones consistently exerted a positive effect on economic well-being within their borders. Naturally, the scale and extent of economic spillover across zones varies significantly. Yet a straightforward accounting of the ZEDE model suggests at least a base level of economic benefit.
In particular, SEZs exert a positive effect on the infrastructure in their surroundings, being associated with new road, rail, and port investments to facilitate movement of goods from within the zones to external markets. In Honduras, this can be observed most recently with the Port of Satuyé in one of Honduras’s ZEDEs. Strategically located on Honduras’ Caribbean coastline, the port could be the recipient of close to $600 million in new investments to update critical infrastructure—a potential boon to U.S. nearshoring efforts in Central America. Constructing these projects also employs significant numbers of locals, with one ZEDE requiring that at least 90 percent of day labor opportunities be provided to Hondurans. Some zones have also adopted various stipulations requiring salaries to be a fixed amount above the Honduran minimum wage.
Beyond construction and infrastructure, one of the key advantages ZEDEs have is the regulatory efficiency and flexibility, which lets the zones create more inviting environments for businesses than the overall macroeconomic environment in Honduras. ZEDEs make it easier to hire and fire workers, register a business, and pay lower taxes than elsewhere in the country.
Critics of the ZEDEs maintain that the zones will not accelerate Honduran economic growth, or even prove detrimental by denying the Honduran central government tax revenue. While ZEDEs are required to pay 12 percent of their total tax revenue to the government (on top of the cost of services within the ZEDE, which are covered by the ZEDE itself), this could be a low value depending on the internal tax rate. Furthermore, ZEDEs are exempt from paying sales taxes, the source of 43 percent of Honduras’ revenue. ZEDE proponents point out that, in practice, the ZEDEs adopt low but highly efficient tax rates, which tend to encourage more economic growth and to generate more tax revenue. Rates may be low, but the tendency to collect taxes and deter evasion is high and can align with maximizing, not minimizing, tax revenue in Honduras, where non-payment of value-added taxes is estimated to cost the government 2.7 percent of GDP per year.
While counterfactuals are notoriously difficult, the argument that the ZEDEs will starve the Honduran government of needed revenues is vulnerable to the counterpoint that much of the investment being channeled into the ZEDEs would likely not have been made at all in their absence. It is improbable to simply assume that somehow this level of investment would be directed into the larger Honduran economy absent the ZEDEs.
A final argument raised against the ZEDEs concerns their economic impact. Despite some 10 years since the authorization of the Organic Law, the three operational zones in Honduras have little to show for them, opponents say. Such a contention should be treated with skepticism. To be sure, the ZEDEs have existed on paper for a decade; however, the first ZEDE was approved only in 2017, with others following in its wake. Even after opening their doors, the business of attracting companies, renovating, and constructing new offices, transportation, and industrial facilities takes time. Some of the most productive SEZs globally have operated for decades before reaching their potential. It would be a colossal mistake for Honduras to end the ZEDE project just as global trends toward nearshoring and reorganizing supply chains have intensified and created powerful tailwinds that ZEDEs are well-equipped to help Honduras ride.
Nearshoring and Geopolitics
In the aftermath of a succession of economic, health, and security crises that left global supply chains snarled, the United States has brought a renewed focus to bear on bringing key industries closer to home. However, to entice companies to uproot their production and transport lines and “nearshore” them, countries like Honduras need more inviting macroeconomic conditions. Unfortunately, many of the ideal destinations for nearshoring, including Honduras, continue to struggle with the challenges of endemic corruption, insecurity, and outdated regulatory environments, which pose obstacles to fulfilling the promise of nearshoring. Faced with these conditions, it makes sense to have geographically defined areas marked by their regulatory independence, meaning that ZEDEs offer investors the chance to create jobs in Honduras without having to wait for top-down policy changes.
Ensuring the realignment of U.S. capital and supply chains to Honduras is not only important for Honduran economic growth but aligns with key U.S. strategic priorities in Latin America. Honduras is currently one of just 14 diplomatic allies of Taiwan worldwide, and one of eight remaining in the Western Hemisphere. Maintaining this recognition requires a strong economic focus to allow these allies to stand firm in the face of predatory efforts by the People’s Republic of China (PRC) to peel them away with promises of gifts and investment windfalls. The case of neighboring El Salvador is illustrative in this regard, where plans for a Chinese-operated SEZ encompassing 14 percent of Salvadoran territory and nearly half the country’s coastline have been floated. The zone would bar U.S. and European companies from competing within its borders, speaking to the potential for a far more restrictive environment for private enterprise, should similar PRC-backed zones become ascendant in the hemisphere.
Even more concerning from the perspective of great power competition in Latin America is the risk that PRC-backed SEZs and the trade and transit infrastructure found within them could be “dual-use” and potentially exploited by the People’s Liberation Army or People’s Liberation Army Navy. Indeed, Chinese investment projects around the world from the United Arab Emirates to Equatorial Guinea have been accused of serving both trade and military purposes, their specifications often mired in opaque contracts. In contrast to this model, the ZEDEs are remarkably transparent, and competition-minded. Only through increased transparency can the United States hope to deter the backroom deals that often mark the PRC’s approach to the Western Hemisphere.
In light of this array of geopolitical considerations, U.S. policymakers from both parties have taken an increased interest in the role ZEDEs can play. A recent bipartisan letter from the U.S. Senate expresses growing concerns over the efforts of the Castro government to erase the ZEDEs wholesale.
Ultimately, You Can’t Eat Sovereignty
In April 2022 the Honduran Congress took the first step toward ending the ZEDEs, with a unanimous vote to repeal the Organic Law. This alone did not end the zones, which, as a constitutional amendment, will require ratification in the 2023 session as well. Even then, legal stability provisions found in documents like the Honduras-Kuwait Treaty of Reciprocal Investment should guarantee the stability of the ZEDE law for 50 years. Combined with the fact that hundreds of millions of dollars have already been invested in the ZEDEs, a move to terminate the zones today would—and already has—touched off a messy legal battle under the Dominican Republic-Central America-United States Free Trade Agreement (CAFTA-DR) consultation mechanism.
If arbitration moves forward, it is a lose-lose scenario. ZEDE operators may need years to get the payout they are expecting, while the government of Honduras, which may find itself on the hook for billions, would experience reputational damage that will likely see its opportunity to catch the nearshoring wave evaporate. Critics of ZEDEs argue that it would be wrong for the U.S. government to muster resources to defend U.S. investment in such an ill-conceived idea as the ZEDEs, tainted by their “original sin” and association with the disgraced Hernández administration. However, selectively defending U.S. investment based on politics would mark a dangerous “open season” for anti-U.S. governments, populist-nationalist governments, and U.S. strategic rivals to pursue similar projects elsewhere. Just imagine how such a dereliction of duty to defend U.S. investment abroad would be seen in Beijing.
As the Honduran Congress winds its way toward repeal of the ZEDEs, there should be strong incentives for both ZEDE promoters and critics to come together and identify practical reforms. In response to criticisms that the ZEDEs may abrogate human rights within their borders, an independent oversight body could be created, empowered to publish reports on zones’ compliance with the 2013 law’s requirements that human rights protections within the ZEDEs equal or surpass those enshrined in the Honduran constitution. Congress could likewise amend the ZEDE law to remove a provision read by some as allowing land expropriation by the zones. A recent freedom of information request in Honduras reveals that to date, no zone has attempted to expropriate land using this provision, and its disappearance would not be missed. Such initiatives offer a far more sustainable path forward to mediate between legitimate concerns and the economic and geopolitical benefits furnished by the ZEDEs.
It is unfortunately all too common these days for policy experts to make nefarious claims about the validity and independence of research findings that do not align with their view. But the Americas Programs’ corpus on ZEDEs represents a critically important and scholarly contribution to the literature on SEZs in general and ZEDEs in particular, especially with respect to navigating a more sustainable path forward in Honduras. According to a recent Gallup Poll, two-thirds of Hondurans believe the top priority of their government should be generating employment. The Castro administration’s efforts against the ZEDEs actively undermines this effort—all in pursuit of vague notions of “recovering sovereignty.” Worse, ZEDE critics advocate for the U.S. government to step aside and focus instead on other areas of the bilateral relationship. But ultimately, you cannot eat sovereignty. Repeal of the ZEDEs will represent a pyrrhic victory for Honduras.
Ryan C. Berg is director of the Americas Program and head of the Future of Venezuela Initiative at the Center for Strategic and International Studies in Washington, D.C.