Pilot free trade zone in Shanghai to build open economy

Author: Bo Chen, Shanghai University of Finance and Economics

The decision to establish a pilot free trade zone (FTZ) in Shanghai stems from a number of internal and external problems that China now faces.

While slowing economic growth is forcing the country to seek out deeper reforms and new growth engines, external moves that could be billed as ‘foreign aggression’ have played a bigger role in prompting the creation of the FTZ.

The influence of the Trans-Pacific Partnership Agreement (TPP), initiated by Singapore in 2005, grew significantly after the United States signed up in 2008. Since then, the TPP has moved in line with American interests.

As part of its bid to build a unified market in the Pacific Rim by 2020, the TPP requires member countries to eliminate all tariffs and open up their agricultural and financial services sectors. As such, Japan and developing countries like China have found themselves in the crosshairs.

The US-influenced TPP did not receive a positive response from Asia Pacific countries at first. But after the United States convinced Japan and Vietnam to join the negotiations (it also signed an FTA with South Korea in October 2011), China has had to reconsider its position. China knows it will pay a higher price if it is excluded from such a unified market.

China expressed interest in joining the TPP for the first time during a fresh round of the Sino–US Strategic and Economic dialogue in July. However, time is of the essence if it hopes to meet the TPP’s requirements for full liberalisation before the 2020 deadline.

And despite rumours about what reforms the FTZ may herald, its long-term policy objectives will generally remain consistent with the requirements of the TPP.

Construction of the FTZ is part of a series of reforms by Premier Li Keqiang, which are focused on de-leveraging debt, reducing financial support and upgrading industrial infrastructure in order to better allocate resources through a market mechanism. Many scholars have compared the Shanghai FTZ to the situation in Shenzhen in 1979, when China began experimenting with more liberal economic policies. Others have drawn analogies with the country joining the World Trade Organization in 2001.

The FTZ has four main goals. The first is achieving zero tariffs on all merchandise traded, including agricultural products. The second involves protecting intellectual property rights, and making sure that labour, environmental and safety conditions meet international standards. The third centres on enhancing economic and regulatory fairness and transparency, and removing subsidies and preferential support for specific industries and state-owned enterprises. The fourth is to fully liberalise the financial services industry, and open up the capital account to facilitate the free convertibility of currency and movement of capital.

The FTZ should also aim to include all major industries to create a fair sense of competition among state-owned, private and foreign businesses. It should follow the negative-list approach of granting access to any businesses that are not prohibited, and change the traditional method of examining and approving tenants to a registration-based system.

In short, the pilot FTZ scheme should serve as a perfect opportunity to build an open economy on a macroeconomic level by testing out innovative systems in the context of global competition. From this, China can learn about other economic management methods and assess the impact of full liberalisation.

Bo Chen is Deputy Chair at the Department of International Economics and the Deputy Director of the Research Center on Free Trade Zone, Shanghai University of Finance and Economics.

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