Pilot free trade zones should now go national

December 4, 2014 by Ken Davies

The first anniversary of the Shanghai Pilot Free Trade Zone this September was a non-event, with few achievements to proclaim. Although other cities are vying to set up similar zones, there seems to be little enthusiasm among investors to set up enterprises in them. Three and a half decades into the economic reform process, it is now time to push forward with reform policies at national level, then focus on local implementation – not the other way around.

The pilot project approach worked well in the early part of the reform period because, daring as it was, it was pushing at an open door. The Special Economic Zones (SEZs) in Guangdong (in Shenzhen, Zhuhai and Shantou) and Fujian (in Xiamen), set up in 1980, formed an uneven but effective test-bed for the “open door” policy of encouraging inward investment. Far from Beijing, they could not contaminate the capital, and if they failed to develop they could be shut down without too much trouble. Each was located near a source/conduit of foreign capital: Shenzhen, by far the most successful, next to Hong Kong; Zhuhai adjacent to Macau; Shantou and Xiamen opposite Taiwan.

Things are quite different now. Shanghai is the heart of China’s financial system, with the larger of the two mainland stock exchanges and the headquarters of many multinationals. Isolating or closing an experimental zone adjacent to the central business district of Shanghai once it has really got going is not a viable option.

And today’s reform challenges are of a different character and a higher order of complexity. In 1980, China was emerging from three decades of Stalinist central planning, lacking the basic institutional framework for an open, market-driven economy, let alone any consistent ideological rationale for one. At the same time, the Chinese people, whose living standards were still below even the 1957 level, were desperate to get the economy moving. So the SEZs and the open-door policy they represented were essentially taking the brakes off the economy while accepting money from abroad to help create jobs.

By contrast, China’s problems are now those resulting from the dramatic and sustained success of the open-door policy. China is no longer a poor developing country. Instead, it faces the challenge of restoring productivity growth through structural rebalancing and innovation so that incomes per head can continue to rise, and it now needs to avoid the “middle-income trap” of countries like Malaysia or any “lost Japanese decades”. Rather than taking its foot off the brake pedal or stepping on the gas, the leadership needs to roll up its sleeves, get out the manual and start tinkering carefully but decisively with the engine.

Shanghai was deliberately left out of the first package of reforms. There is a widespread presumption that this was because of its role in spearheading the so-called “Great Proletarian Cultural Revolution” of the late 1960s. With the advent of the “Shanghai clique” to national power in Beijing after the 1989 Tiananmen Massacre, the city regained the reform initiative, especially after economic development was reignited in early 1992 during Deng Xiaoping’s “Southern tour”.

During the 1990s, Shanghai resumed the key role in economic development that it had since the late nineteenth century, with massive infrastructure investment and an expansion of the city eastward into the new Pudong New Area in 1993. The city’s skyline is no longer popularly envisaged as the old buildings stretching along the Bund from the Peace Hotel, but more as Pudong’s skyscrapers and the Oriental Pearl TV Tower on the opposite side of the Huangpu River. The 2010 World’s Fair, Expo 2010, was held in Shanghai, the “next great world city”.

Three years after Shanghai’s modernization was symbolically crowned by Expo Shanghai, the announcement on 29 September 2013 of the establishment of the China (Shanghai) Pilot Free Trade Zone marked an effort by the Chinese leadership, specifically Premier Li Keqiang, to regain the economic reform momentum in a form redolent of Deng’s 1980 and 1992 initiatives. The slowdown in GDP growth provided both an opportunity and a motive for reform, which was embodied in a package of policy measures adopted by the Communist Party of China Central Committee plenum in November 2013. As the name (i.e. beginning with “China”) implies, this is an area for experimenting with policies to be applied nationally if they succeed in the zone.

The Free Trade Zone, all of it in Pudong, is a consolidation of four free trade zones that have been around for some years: the Waigaoqiao Free Trade Zone (set up in 1990), the Waigaoqiao Free Trade Logistics Park (approved in 2003), the Pudong Airport Comprehensive Free Trade Zone (2009) and the Yangshan Free Trade Port Area (2005, expanded in 2012).

The aim of the zone is to pilot measures which push economic reforms to a new level, meeting widely-voiced concerns of international investors and complying with policy recommendations made by international bodies, especially since China’s admission to the WTO in December 2001. The policies to be tested are in key areas of economic policy relating to rebalancing of the economic structure, promoting innovation and further internationalising the Chinese economy.
The easiest measures to implement so far relate to straightforward trade and investment streamlining, including more efficient customs procedures, simpler registration of foreign investment projects and the cutting of red tape for outward investors.

Policy areas in which the pace of change is more gradual, and probably controversial among the country’s leaders, include easing foreign investment restrictions by a negative list approach, further internationalizing the renminbi, allowing convertibility of the renminbi on capital account and liberalising interest rates.

The zone is only 29 square kms in area (though it could well expand to fill the whole of Pudong, which is 1,210 square kms). Not surprisingly, manufacturers have not found space to set up major plants. On the other hand, distribution companies such as Amazon and DHL are establishing large hubs there. But, despite official statements to the contrary, the authorities do not seem happy that only around 12,000 firms have so far started operations in the zone.

They should not be surprised. What stakeholders now need is not a new Shenzhen, but national-scale reforms. Making the renminbi convertible on capital account in a small area of China is impractical – and could be disproportionate. Businesses all over China need liberalized interest rates – and a genuine credit market – now, not after it has been tested in Pudong. The Shanghai FTZ may play a useful role in training better customs officials and the like, but this is small beer compared to the heavy responsibility for economic reform for which it has not been adequately equipped by the central government.

All these reforms will eventually be implemented in the Shanghai FTZ. But by the time they are, they will probably already have been adopted at national level.

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