Tiptoeing to Freer Markets – China and the Shanghai Pilot Free Trade Zone

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Shanghai Waterfront


I apologize to all those who regularly read these posts.  They have, unfortunately, failed to be regular recently.

But I have been out there in the wide world – first in Russia at the St. Petersburg Summit and all last week in China. I shall report more on both these trips in the near future.

I did want to report, however, on an interesting experiment now underway – at least as of Sunday September 29th – China’s Shanghai pilot free trade zone (FTA).The FTA, it appears, is the cutting edge of the new leadership’s effort to bring more market and less regulation to China’s economy.  The FTA is 29 square kilometres in the north eastern section of Shanghai – stringing together areas of docks, hangars and warehouses in the Pudong district.

Though hardly a graceful landscape the area reflects the most advanced effort to free up the Chinese economy.  According to the State Council the FTA is to “promote the opening up of the service sector and to reform the management of foreign investment.”  Now a free trade zone consisting of 29 square kilometres is hardly the unleashing of the market in China.  But the approach and timing is important.

This experiment is is just over a month from the Third Plenum where there are expectations of significant economic reform being unveiled as the leadership tries to shift into “high gear” in efforts to move from an export model to a more domestic model of economic growth in China.  All this is designed to create a sustainable model of more balanced growth.  There are indications that Prime Minister Li Keqiang has been a strong backer of the FTA.

As for its minuscule size, one only need look back in the not too distant past to acknowledge that China has often utilized pilot initiatives – notably early in the life of Deng Xiaoping’s economic reform.  Then officials permitted the establishment of special economic zones (SEZs) – where more market oriented initiatives were allowed and proved their worth.

So what’s up in the zone.  Well interest rate liberalization and an opening of the capital account will be permitted.  The renminbi will be freely convertible within the zone. Domestic banks in the zone will experiment with market-set deposit rates.  This change could lead to significantly greater competition in the banking sector.  The FTA will encourage outbound investment by Chinese companies and companies will be permitted to use the renminbi in cross border activity.  Some 11 financial institutions have apparently already been green-lighted to set up branches in the FTA.  This includes both a number of the big China banks like Bank of China and ICBC but also foreign banks such as CITI.

Foreign firms will be able produce and sell videogame consoles and offer some internet services.  One of the first licensed was a joint venture of Microsoft and BesTv. The big whisper was that the zone will permit access to Facebook and YouTube – yippee from one foreigner who has suffered from not having VPN.

Foreigns will be permitted to own up to 70 percent of joint venture recruiting firms while Hong Kong and Macao investors will be permitted to set up solely funded recruiting firms.  The amount of paid in capital will also be reduced from $300,000 to $125,000.

And there are other changes as well.  Notwithstanding that economic pilot projects have been utilized in the past to bring about change, the open question is whether reforming at the local level makes it easier or in fact more difficult to role out changes at the national level.  There is much resistance to lifting the heavy hand of regulation and injecting potentially far more competition – a move opposed in particular by many in the state-owned enterprise sector.

Strength or weakness – only time will tell.

Image Credit:  Hanehassan.com

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