Shanghai's New Free-Trade Zone: Reform Breakthrough or Hype?

View from Shanghai Pudong business district Photograph by Colourbox

More than three decades after China launched its first special economic zone in Shenzhen, aimed at jump-starting reforms and attracting foreign investors, China’s leaders are trying again.

On Sept. 29, the Shanghai Free Trade Zone, covering 28 square kilometers of the Pudong district, will open for business. “Priority will be given to easier investment access and greater openness in trade in services. We have also adopted measures to facilitate foreign trade and promote a steady growth in import and export,” said premier Li Keqiang, the top proponent of the new zone, in a speech in Dalian on Sept. 11.

Some might question the need for one more special zone offering favorable investment policies. Rather, it’s the business climate of all China, facing what many view as an ongoing crackdown on multinationals, that needs working on. Foreign infant formula makers have been hit with heavy fines for price fixing, overseas pharmaceutical companies exposed for corrupt practices, and multinational auto giants could be targeted next for allegedly overcharging for their imported vehicles. Meanwhile, an eagerly anticipated meeting of top Communist Party leaders coming in November could usher in far-reaching national, rather than just local, economic reforms.

Regardless, economists, analysts, and enterprises in China are all wondering just what the Shanghai zone will offer (it’s aimed at serving both Chinese and foreign companies). But even with the opening just over a week away, details may not soon be forthcoming. “Reform guidelines in the FTZ would not come along with the official launch of the FTZ at the end of September but will be gradually released before the end of this year and into next year,” the official Xinhua News Agency reported Sept. 18, citing comments made by Kuai Zhenxian, chief economist with Shanghai Waigaoqiao Free Trade Zone Development Co., at a press conference in Shanghai.

What do we know? For one, the zone should be far more open to foreign investment across a large variety of different industries—China today still restricts 100 percent foreign ownership in sectors that range from autos to media. The zone will use what Premier Li and others have called a “negative-list approach” for investment—meaning any sector not specifically mentioned as off-limits or restricted will be permitted in the zone.

“The central government has committed to suspending current FDI regulations within the zone and providing a ‘prohibited’ or ‘negative’ list that stipulates which activities and sectors are not allowed,” write Royal Bank of Scotland analysts Louis Kuijs and Tiffany Qiu, in a Sept. 19 research note. “This will mean more transparency, less red tape, and probably more freedom for business.”

Another area where the zone could break new ground is in allowing a more open financial system, including freer yuan convertibility and liberalized interest rates. The key question is whether the financial flexibility will be allowed to seep into the rest of China.

“If the authorities restrict the companies to conduct all their business only within the zone, the impact will be very small,” write Standard Chartered analysts Stephen Green, Wei Li, and Robert Minikin in a Sept. 6 research note. “On the other hand, if the freed-up financial services within the zone are accessible to any firm in China that merely sets up a representative office in the zone, China would basically have opened up its capital account.”

Indeed, for those who favor a more rapid economic and financial opening for China, the hope is the more liberal policies to be allowed in the zone, if deemed successful, could soon be extended nationally. The fear is that if instead they are viewed as destabilizing, foot-dragging could ensue. “If the Shanghai FTZ fails, China’s overall reforms will fail,” warned Chen Bo, an economist at the Shanghai University of Finance & Economics, Xinhua reported Sept. 18.

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