China Tests New Free Trade Zone in Shanghai

China Tests New Free Trade Zone in Shanghai

William Ide

September 26, 2013

SHANGHAI - Early next month, China will unveil a new kind of free trade zone in Shanghai. Despite a lack of details about the area, which will include 29 square kilometers of Shanghai's Pudong district, it is already being showcased as a window into a more liberal Chinese economy.

The Chinese economy is slowing and there are growing concerns about property bubbles and rising debt. In an effort to breath new life into the economy, China's new leaders are searching for ways to turn the country into something more than a global manufacturing powerhouse.

"In China, we have realized that the manufacturing of products has used up resources and damaged the environment," said Sun Lijian, an economics professor at Shanghai'sFudan University. "Today, we need to use this model to bring about the transition towards a more high-level growth model, so we want to do more in the service sector, do more research and development, and more exchange of talent."

The new zone could lead to the liberalization of more than a dozen industries. The free exchange of China's currency - the yuan - is expected to be a key component of the zone, which will include four customs areas in which goods can be stored and avoid value added taxes or tariffs.

China has long relied on exports and investment to spur its growth, but that approach has reached its due date, said Shaun Rein, managing director of the China Market Research Group.

"China's government now is switching more towards domestic consumption and services," said Rein. "In order to really boost up consumption and services, the government has to attract a different type of foreign investor and has to boost domestic spending in a different way."

Rein said the opening of the new zone is hoped to attract more foreign investment, banking services, insurance and more creative technologies. Right now, said Rein, Shanghai's economy relies too much on heavy investment, particularly real estate.

You make the cake

In the past, it was the government that took the lead in boosting investment and growth. However, the new zone seeks to change that by giving investors the tools to create money-making opportunities, instead of handing it over to them like cake.

Fudan University's Sun said that is why the government is taking a more hands off approach.

"We must change the approach where the government takes the lead in investment and instead let the market determine demand and where investments should go," Sun said.

Taking a small step in Shanghai could lead to reforms elsewhere.

"The idea is that if you have a more market oriented financial system in this free trade zone, that's going to create a much healthier financial system throughout the entire country," Rein said.

News of the plans has other regions in China lining up to receive the same treatment. When the government approved the plan for Shanghai in August, Tianjin Zhoushan and cities in Guangdong also started seeking free trade zones of their own.

Hong Kong is also watching developments cautiously, and earlier this month Li Ka-shing said the port city needs to raise its competitiveness if it doesn't want to loose out to Shanghai. Li is one of Asia's richest men and chairman of the Hong Kong-based companies Cheung Kong Holdings and Hutchison Whampoa Limited.

"Every city in China basically wants to have a free trade zone like this because they know it's going to boost investment, employment and GDP growth, but the government here tends to be very cautious," said Rein. "They like to put up a trial balloon like a free trade zone or duty free and let that run for five or 10 years."

Opportunities and risks

On the other hand, Professor Sun believes change could come sooner if the pilot program in Pudong is a success.

But he said the main reason the plan is being rolled out on such a small scale is because there are risks that come with it. Sun said not only are there concerns the freeing up of financial restrictions could lead to the flight of capital from the country, but there are also concerns speculation could run rampant.

"There are fears that people who enter this zone and are given the tools to make the cake will instead use those tools to do bad things," Sun said.

China is concerned that if it doesn't carry out reforms correctly it could run into the same problems its Asian neighbors have had in the past.