Yiping Huang Australian Financial Review 21 October 2013
THE Shanghai Free Trade Zone (FTZ) launched last month is touted as an important part of the Chinese government's new reform strategy.
By supporting the China-US Bilateral Investment Treaty (BIT) talks and also preparing for eventual participation in the Trans-Pacific Partnership (TPP) negotiations, the Shanghai FTZ may help take China's economic opening to a new level. These steps could also benefit the Chinese economy in a similar way to WTO accession more than a decade ago. But there are still uncertainties about what the Shanghai FTZ can achieve.
Some commentators compare the Shanghai FTZ with the Shenzhen Special Economic Zone (SEZ) launched about 30 years ago. It is certainly correct that both are important steps undertaken by the central government to liberalise the economy. However, there are key differences. While the Shenzhen SEZ focused on manufacturing industry, the Shanghai FTZ concentrates mainly on service sector-liberalisation. The Shenzhen SEZ's initial success led to large numbers of SEZs and industrial parks across the country. By contrast, senior policymakers indicate that there will be no other FTZs of the same type. The Shanghai FTZ itself will likely be short-lived as most of the experimental policies, if successful, should be extended to the whole nation within two to three years.
The Xi Jinping-Li Keqiang leadership's new opening strategy has two clear motivations..
The first motivation is to support sustainable growth in China. While China has achieved very rapid economic growth since the beginning of economic reform, serious imbalance, inefficiency and inequality problems dim the outlook for continuation of strong growth. China's GDP per capita has also risen from $US200 in 1980 to $US6000 in 2012, and it is now a middle-income country. The once-unlimited supply of labour has been replaced by labour shortage and rapid wage growth. All this means that China needs further reforms to improve economic structure and support industrial upgrading. Entry to the WTO at the end of 2001 had a positive effect on the economy. But the Chinese economy now needs new impetus to take it to the next level. The new opening strategy underpinned by the Shanghai FTZ will hopefully serve that purpose.
The second motivation is to be a part of the rule-making process for the future of the world economy. Given the difficulties with the WTO's Doha Round, the TPP negotiation, if successful, may well set the blueprint for a new standard of global economic liberalisation. Although China has expressed a suspicion of, and reluctance to join, the TPP, a number of senior officials have now indicated that China wants to participate in the negotiations. This is because the high standards for state-sector reform, protection of intellectual property rights, service-industry liberalisation and the freeing of agricultural trade are all potential reforms on which the Chinese government wants to embark in the national interest. As one official put it, a TPP without China is incomplete on its own – but it is also a loss for China. More importantly, by participating in TPP negotiations, China would be able to help make rules for the future global economy.Outcomes uncertain
Still, it is not yet clear exactly what the Shanghai FTZ will achieve. And there are question marks about the government's support for the Shanghai FTZ. The public was surprised no national leader was at the FTZ's opening ceremony, and there are reports of reservations among government departments about the policy experimentation.
A more fundamental issue is whether service-sector liberalisation can actually be effectively tested in such a small area. Local authorities have been emphasising the importance of the Shanghai FTZ to interest rate, exchange rate and capital account reforms, but it is not clear how it will work. Taking interest rate liberalisation as an example, can the FTZ form market-based interest rates among just a dozen banks and another dozen corporations without the reference of a risk-free yield curve? Would the FTZ set strict quotas for every institution or would it establish strict capital account controls vis-à-vis the rest of Shanghai? The same applies to other service industries. Would a new telecom company established inside the FTZ be able to service clients outside the FTZ? If the answer is no, then no firm would want to establish operations in the FTZ. If the answer is yes, it means nationwide liberalisation.
Recall how, at the beginning of the reform period, the Shenzhen SEZ had a key demonstration effect as almost nobody had experience in a market economy. But now China's transition to a market economy is more than halfway there. And many remaining reforms are not conducive to experimentation in a small area. So while the Shanghai FTZ is a very important step, as a part of the government's new opening strategy, a more promising focus may be on the reform programs to be unveiled at the Third Plenum of the 18th Party Congress within the next few weeks.
