Shenzhen II?: The New Shanghai Financial Free Trade Zone

Less than 35 years ago, China established its first special economic zone in Shenzhen, a prefecture (Note) bordering Hong Kong. This model is about to be expanded with the establishment of a new financially oriented free-trade zone in Shanghai, which could prove a major breakthrough in that city’s quest to become East Asia’s financial capital. The “China (Shanghai) Pilot Free Trade Zone (FTZ)” is located in eastern Pudong, the Shanghai’s suburban district (qu) that includes the huge new Pudong business district, across the river from the central business district in Puxi. 

The potential here for rapid growth can be seen by reviewing the success of the Shenzen special economic zone (SEZ), When founded, the SEZ contained little more than a fishing village, but soon was transformed into a manufacturing and trading center, propelled by a less constrained regulatory environment. Foreign investment soared. The success of the Shenzhen model led to expansion of the zone and other special economic zones were established around the country. Shenzhen’s prosperity extended into neighboring Pearl River Delta prefectures such as Guangzhou, Dongguan, Foshan, Zhuhai and Zhongshan. Investment friendly policies were applied virtually across the nation in the years that followed. Today, for example, Apple makes many of its tablets in Chengdu, the capital of Sichuan, 1200 miles (2000 kilometers) inland via China’s larger equivalent of the US interstate highway system.

Yet the economic advances of the special economic zones were anything but inevitable. Chinese leader Deng Xiaoping faced strong opposition from some high government officials, who were intent on limiting the scope of the Shenzhen experiment. Some even hoped to shut it down altogether (see Ezra Vogel’s Deng Xiaoping and the Transformation of China). Moreover, the economic advance of China involved, as the late Nobel Laureate Ronald Coase and Ning Wang relate in How China Became Capitalist  much more than conscious economic policy. Coase and Wang characterize the government’s light handed policies as permitting the “marginal revolutions” in individual entrepreneurship, township and village enterprises (locally owned enterprises) and private farming. These, and the special economic zones, were the driving forces in the Chinese economic miracle.

And, as is predictable, not everyone is happy with the results of China’s transformation. There is persistent criticism of the inequality of income that has developed in China over the period. Yet, sitting on the sidelines, it is easy to second-guess the results of national economic policies, which do not always produce the intended outcomes. Suffice it to say that since 1980, China, one of the poorest nations in the world, has pursued policies, both of commission and omission, that have together lifted more people from poverty than ever before in history (See: Alleviating Poverty: A Progress Report). There is probably not a more important domestic objective for governments.

Shanghai’s New Financially Oriented Free Trade Zone

In the past the free trade zones focused principally on manufacturing. The new Shanghai free trade zone is the first to specialize in finance. The zone stretches along the Pacific Coast from north of Pudong International Airport, south through the large new town of Nanhui and across the Donghai Bridge to the new deep water port, which is an important component of the Port of Shanghai, now the largest in the world, and is designed to focus on finance. Initially, it will cover 11 square miles (29 square kilometers), but Hong Kong’s South China Morning Postsuggests that it might eventually be expanded to cover all of the Pudong New Area. This would expand the area to 467 square miles (1,210 square kilometers), an area nearly as large as the San Francisco-Oakland built up urban area.

According to The Wall Street Journal “China's government said it would turn a new free-trade zone here into a laboratory for remaking the country's financial sector...” The Journal continues: “Financial-sector changes are at the heart of the experimentation in the zone: letting the market, rather than regulators, set interest rates and allowing firms to convert money more freely from yuan to foreign currencies and move the money overseas.”

The Chinese based Global Times characterized the new free trade zone as an important step in China's economic reform and the internationalization of the yuan. 

As in the case of Shenzhen, government officials are characterizing the establishment of the new “Pilot Free Trade Zone” as an experiment. The Journal reports that the project is championed by new Premier Premier Li Keqiang, just as Shenzhen was championed by Deng Xiaoping. Should the zone be successful, it would not be surprising to see other such zones established. Perhaps, it will lead to an eventual liberalization of financial regulation across the nation, which is critical for China’s future development.

Shanghai American Chamber of Commerce president Kenneth Jarrett responded positively to the announcement, telling China Daily: "One thing significant about the zone is its relationship to China's economic reform agenda. Because there are a lot of talks about the need to rebalance the economy and make it more market-oriented, the FTZ (free trade zone) is a signature piece for the whole process."

Yet, this will be far from a total free-market paradise. The government has announced a list of restrictions, including industries in which foreign investment will not be permitted and industries in which investment will be limited to joint ventures with Chinese companies.

Chinese sources emphasize the evolutionary nature of the restrictions. According to Shanghai Daily, “The list is a temporary version for 2013 and the zone regulators will update the list every one or two years to better facilitate liberalization policies testing in the free trade zone.”

Differing Views

The new free trade zone move comes as analysts increasingly suggest the need to liberalize its financial sector. The Pilot FTZ could lead China’s financial sector toward greater integration into the globalized economy. This would strengthen China’s integration with the world, and could pose a major challenge to established financial centers, such as New York, London, Hong Kong and Singapore, In an editorial, The South China Morning Post (SCMP) speculates that the reforms begun with the Pilot FTZ could eventually undermine Hong Kong’s position as Asia’s financial center. The SCMP further notes that “The ultimate effect” of the Pilot FTZ “could be to help speed up economic reform nationwide. And that might be the bigger threat to Hong Kong.”

If the skeptics are right, the restrictions and slowness of reform could limit the effectiveness of the zone and the challenge it poses to Hong Kong and other global financial capitals.  Such a view may be naïve. Other views are that reforms could lead to far more important consequences both in Asia and the World,.

The most significant impacts could be on the United States, at least if former International Monetary Fund economist Arvind Subramanian is right. In his controversial book, Eclipse: Living in the Shadow of China’s Economic Dominance, Subramanian predicts that China will replace the United States as the world’s dominant economy by 2030 and that the yuan could replace the dollar as the principal reserve currency by that time. This could become more plausible if the financial liberalization apparently at the heart of the Pilot FTZ effort proceeds with dispatch.

History: Repeating Itself?

The signs from China are not completely clear. Bob Davis and Lingling Wei have just published an analytical The Wall Street Journal article that notes that President Xi Jinping has “veered left on some political issues.” Yet, indications on the economic front could be the opposite. The article focuses on Lie He, Xi Jinping’s leading economic advisor, Liu He, who Harvard’s 2001 Nobel laureate Michael Spence calls “an example of Chinese pragmatism," Spence adds that  Liu "…thinks markets are important mechanisms for getting things done efficiently," but "they're not religion to him."

Deng Xiaoping famously talked of crossing the river by “following the stones.” This cautious approach uses seemingly glacial policy changes that gradually initiate major change.This is how China has evolved over the past 35 years. Again, the Chinese appear to be choosing caution. This is not fast enough for some analysts, but this may also be a development that could augur many changes, not only for China, but for all its primary competitors in Asia and elsewhere.

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Note: The alternate term “prefecture” is used to denote the local jurisdictions into which all of China’s land area is divided. These go by various terms, with “municipality” or “city” used most frequently. In each case, municipalities are more akin to metropolitan areas (or even larger areas), which include the built-up urban areas and substantial expanses of surrounding rural territory.

Photo: Pudong, Century Avenue toward the China (Shanghai) Pilot Free Trade Zone (by author)