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With Shanghai FTZ, Is CCP Opening Pandora’s Box?

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China Power

With Shanghai FTZ, Is CCP Opening Pandora’s Box?

If the CCP is hoping for limited reforms with the new free trade zone, it might get more than it bargained for.

The Shanghai Free Trade Zone officially opened last Sunday, a development that will either usher in a new era of reform or represent a setback, depending on your perspective.

Approved in July by China’s State Council, the 11 square-mile area (within the Pudong district) is the site of investment, trade and financial reforms.  There are very few specific details available regarding the nature of these reforms. According to The Wall Street Journal and CNBC, they have been listed in a general blueprint and include letting the market set interest rates, increasing the ability to convert yuan, and opening up the shipping, banking, tourism and healthcare insurance sectors to investment by foreign companies.

These reforms will not take place overnight—the government estimates that it will be a three-year process. It’s still unclear what exactly the reforms entail, and investors will have to wait to find out, although a clarification of the reforms is expected in late November. 

There is a lot of buzz surrounding the free trade zone, with many analysts and bankers thrilled by the possibility of a more open China, likening it to the China-changing formation of the Shenzhen Special Economic Zone in 1980. Foreign banks and domestic banks will have much more freedom, and it’s a negative list approach for investment: anything not listed as forbidden is open.  There is also the issue of how the government will firewall this free trade zone. 

In a Standard Chartered research note cited in Businessweek, the authors comment “if the authorities restrict the companies to conduct all their business only within the zone, the impact will be very small. 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.” Particularly where interest rates are concerned, it’s hard to see how the government will be able to restrict activity to the zone.

However, there are a number of caveats. For one, the government has not committed to full convertibility or rate liberalization, and a recent Xinhua article indicates that the zone will be “up to international standards” only after two to three years of “test operation.” 

There is also uncertainty regarding increased internet freedoms in the zone. The official blueprint does not include language indicating reforms, despite some news reports.

Optimistic observers note that Premier Li Keqiang is heavily promoting the zone, but that doesn’t necessarily mean anything. His predecessor, Wen Jiabao, spearheaded plenty of liberal-minded policies which sparked hope, but came to nothing. Other reform projects have not proven to be game changers, like Qianhai’s free trade zone, or have been downright unsuccessful, like Wenzhou’s pilot program which aimed to open lines of credit for small businesses.

The Wall Street Journal makes an interesting observation: “advisers to the Shanghai free trade zone say that copying Deng’s idea today is as much a show of weakness as strength. Chinese leaders are focusing on local reforms, they say, because they don’t have the strength to confront opponents of change head on, including old-line regulators and state-owned enterprises used to preferential treatment by state-owned banks.” 

Indeed, as I’ve previously commented, there are immense obstacles in the way of reform, and the limited scope of this project (geographically speaking) certainly could indicate that the reformers have lost ground. Instead of rolling out these important reforms nationwide, they’re relegated to one part of one city. 

So is this free trade zone a sign of things to come, or a signal that reform is being blocked by special interests? Though it’s feasible that it does represent a setback in a way for reform, once the box is opened, can it be closed again? If these reforms—such as currency convertibility and market-based interest rates—are fully implemented, can they be contained within one small area? The answers will depend on how successful the zone is, as defined by how clearly the reforms are laid out, how efficiently they are implemented, and the results of the reforms. Let’s not forget one thing: just because economic liberalization is the right thing for China doesn’t mean it will happen.