Lev­el­ing the Play­ing Field

The Shang­hai Free Trade Zone is a bold mar­ket experiment to change the busi­ness en­vi­ron­ment in China

Business Traveler (USA) - - FRONT PAGE - By Sarah O’Meara

The Shang­hai Free Trade Zone is chang­ing China’s busi­ness en­vi­ron­ment

The China (Shang­hai) Pi­lot Free Trade Zone has di­vided crit­ics. Launched in Septem­ber 2013, it is the first of its kind; an experiment to lib­er­ate China’s econ­omy and po­si­tion Shang­hai as a global fi­nan­cial cen­ter, with the aim of test­ing how the rest of the coun­try can be opened up to the world mar­ket. But nearly two years into it, many be­lieve change is too slow and in­ef­fec­tive, point­ing out that the zone lacks the busi­ness en­vi­ron­ment, ameni­ties and in­fra­struc­ture found in the nearby Lu­ji­azui cen­tral busi­ness dis­trict.

Lo­cated on the out­skirts of Shang­hai, the free trade area started as an in­aus­pi­cious 12-square-mile stretch of docks, hangars and ware­houses en­com­pass­ing four spe­cial zones si­t­u­ated along the coast. Of­fi­cials had hoped it would be­come a hub for bold mar­ket ex­per­i­men­ta­tion achieved by loos­en­ing reg­u­la­tions across in­dus­tries, in­clud­ing fi­nance, bank­ing, ship­ping, law and en­gi­neer­ing.

In many ways the in­no­va­tive pro­ject re­calls Deng Xiaop­ing’s orig­i­nal spe­cial eco­nomic zones that boosted the coun­try’s econ­omy back in the early 1990s. Dur­ing that pe­riod of“re­form and open­ing up,”Deng’s free-trade zones – known as bonded ar­eas or tar­iff-free zones – en­cour­aged for­eign man­u­fac­tur­ing firms to set up shop in China and ben­e­fit from poli­cies such as tax breaks, cheap land and low wages.

The sleepy fish­ing vil­lage of Shen­zhen across the bor­der from Hong Kong was one of the first ben­e­fi­cia­ries of spe­cial treat­ment, and trans­formed into a sprawl­ing man­u­fac­tur­ing pow­er­house in a mat­ter of years.

Just as Deng’s re­forms helped to gal­va­nize the coun­try af­ter the stag­nant 1980s, the tim­ing of the Shang­hai Free Trade Zone (FTZ) comes the year China’s econ­omy grew at its slow­est pace in 24 years af­ter more than a decade of break­neck speed, a down­trend Pres­i­dent Xi Jin­ping char­ac­ter­ized as the“new nor­mal” for China.

In a speech at the Asia-Pa­cific Eco­nomic Co­op­er­a­tion (APEC) in Bei­jing last Novem­ber, Xi told busi­ness lead­ers that in the fu­ture China would fo­cus on im­prov­ing eco­nomic struc­tures and“in­no­va­tion” to fuel growth, rather than rely on man­u­fac­tur­ing out­put and state-driven in­vest­ment.

In re­cent years, China’s lead­ers have signed a se­ries of in­ter­na­tional free-trade agree­ments that of­fi­cials hope will open up, re­form and stim­u­late growth in China’s con­sumer mar­ket.

But in or­der to meet the de­mands of these agree­ments, China needs to lib­er­al­ize its mar­ket reg­u­la­tions to in­te­grate with in­ter­na­tional stan­dards.

These re­forms are di­rectly linked to the ex­per­i­men­tal poli­cies tak­ing place in the Shang­hai FTZ, ex­plains Pro­fes­sor Bo Chen at Shang­hai Univer­sity of Fi­nance and Eco­nom­ics – a key con­sul­tant on the FTZ’s orig­i­nal blue­print.

“The Shang­hai Free Trade Zone was cre­ated to pro­vide a test­ing ground for such changes,”he ex­plains.“The Chi­nese gov­ern­ment has au­tho­rized Shang­hai’s FTZ to tem­po­rar­ily waive ex­ist­ing laws and reg­u­la­tions so they have space to cre­ate their own.”

But ex­perts say that what Shang­hai’s FTZ of­fers in 2015 is not at all the same as what Shen­zhen of­fered in the 1990s.

In an in­ter­view with the Fi­nan­cial Times at the end of 2014, the Com­mu­nist Party sec­re­tary of Shang­hai Han Zheng noted that the zone was very dif­fer­ent in conception to its pre­de­ces­sors.

Rather than of­fer­ing“in­cen­tives,”which are com­mon to tar­iff-free cus­tom zones and in­dus­trial parks, the Shang­hai FTZ is a test area for in­no­va­tion with no di­rect in­cen­tive pol­icy for in­no­va­tion, he added.

Ac­cord­ing to Jen­nifer Tyldes­ley, Con­sul Eco­nomic at the Bri­tish Con­sulate Gen­eral, those com­pa­nies look­ing for a replay of the past were al­ways go­ing to be dis­ap­pointed.

“If you were ex­pect­ing trade and man­u­fac­tur­ing pro­mo­tion tax breaks of the likes of­fered in the orig­i­nal free-trade zones un­der Deng Xiaop­ing, well it was never go­ing to be like that,”Tyldes­ley says.

“I think that’s what a lot of media and busi­nesses have strug­gled to get their head round. The best way to un­der­stand its goals is to drop the word‘trade’al­to­gether, and think of it as a free zone.”

In her eyes, the zone was in­tro­duced to ex­plore ways to change the re­stricted busi­ness en­vi­ron­ment in China that would cut red tape and make it eas­ier for busi­nesses to act on mar­ket op­por­tu­ni­ties.

“If you look at it from this per­spec­tive, I think it’s been a lot more suc­cess­ful than

the com­men­ta­tors have given it credit for,” says Tyldes­ley.

Some Suc­cess Sto­ries

The zone’s most no­table achieve­ment is the cre­ation of the“neg­a­tive list,”an in­ven­tory of in­dus­tries in which for­eign in­vest­ment is pro­hib­ited or banned. Any com­mer­cial ac­tiv­ity not men­tioned on the neg­a­tive list is au­to­mat­i­cally ac­cepted.

The ini­tial list con­tained 190 ex­cluded items, which was re­duced to 122 this May. Newly opened sec­tors in­clude trans­porta­tion, real es­tate, med­i­cal ser­vices and en­ter­tain­ment fields, with a fur­ther re­vised ver­sion ex­pected later this year.

There has al­ready been some suc­cess: last year, for ex­am­ple, the ban on gam­ing con­soles was sus­pended and for­eign­in­vested com­pa­nies were granted the right to make con­soles in the Shang­hai FTZ and sell them in China. Mi­crosoft was the first to snap up this op­por­tu­nity and launched its Xbox One in Oc­to­ber 2014. The in­tro­duc­tion of the neg­a­tive list also led to the first wholly for­eign-owned hos­pi­tal be­ing es­tab­lished in the zone.

Ac­cord­ing to Xin­hua, China’s na­tional news agency, for­eign in­vest­ments have in­creased ev­ery month since the zone was es­tab­lished, with nearly 1,800 for­eign­in­vested firms set­ting up in the zone.

Nev­er­the­less, for­eign par­tic­i­pa­tion re­mains dis­pro­por­tion­ately low. While 12,600 com­pa­nies have reg­is­tered in the FTZ since its es­tab­lish­ment, only 14 per­cent were for­eign-in­vested, the South China Morn­ing Post re­ported in 2014.

Crit­ics of the for­eign in­vest­ment pol­icy also say the neg­a­tive list is far too long, and a great deal of con­fu­sion re­mains over the specifics of the list.

“Some of the re­stric­tions are nec­es­sary. Ev­ery coun­try has some kind of ex­emp­tions for cer­tain sec­tors. But if the re­stric­tions are purely based on po­lit­i­cal ide­o­log­i­cal con­cerns, Western coun­tries may not buy that ex­cuse,”says Pro­fes­sor Weip­ing Wu, as­so­ciate pro­fes­sor, Hong Kong Bap­tist Univer­sity.

Chen ar­gues that the ob­sta­cle to re­form doesn’t just lie in the word­ing of the rules – but bu­reau­crats’de­sire to im­ple­ment them.

“Chi­nese of­fi­cials are used to in­ter­pret­ing reg­u­la­tions. In many re­spects, that’s the source of their power. The re­form is on gov­ern­ment it­self, which is very tough. Many bu­reau­crats didn’t want to give up their power [over the rules]. It can be dif­fi­cult for for­eign observers to un­der­stand,”Chen says.

“To make the neg­a­tive list work for for­eign coun­tries, of­fi­cials need to re­spect these new laws, and they need time to ad­just to this. We are mak­ing progress, but com­pared to Western coun­tries we have a long way to go.”

China’s lead­ers are keen to speed up the rate of re­form. When Premier Li Ke­qiang vis­ited the zone in Septem­ber 2014 to mark the one-year an­niver­sary of its es­tab­lish­ment, he re­it­er­ated that com­pa­nies should not be held back by “ex­ces­sive gov­ern­ment reg­u­la­tions and ap­proval pro­ce­dures.”

Since then, there has been vis­i­ble progress and fur­ther re­stric­tions have been lifted. In early 2015, for ex­am­ple, the gov­ern­ment an­nounced China would al­low for­eign com­pa­nies to fully own e-com­merce firms in the zone, a move that po­ten­tially opens up the coun­try’s huge online re­tail mar­ket to global com­pe­ti­tion.

Ama­zon has al­ready re­vealed plans to take ad­van­tage of the zone’s less strin­gent trade reg­u­la­tions and es­tab­lish a lo­gis­tics ware­house from which to sell a wider range of prod­ucts in China.

Rate Of Fi­nan­cial Re­form

Per­haps the main source of dis­ap­point­ment lies in the un­ful­filled prom­ises re­gard­ing fi­nan­cial re­forms. When the Shang­hai FTZ was launched, the cen­tral gov­ern­ment pledged to pi­lot a range of eco­nomic

For­eign in­vest­ments have in­creased ev­ery month since the zone was es­tab­lished

changes, in­clud­ing lib­er­al­iza­tion of trade and full-con­vert­ibil­ity of the RMB. It also promised to re­duce state con­trol of in­ter­est rates, cur­rency and for­eign in­vest­ment.

But half­way into its three-year term, for­eign busi­nesses are still wait­ing for pol­icy changes that en­cour­age cur­rency lib­er­al­iza­tion. Last Novem­ber, Shang­hai’s mayor Yang Xiong vowed to roll out an in­sti­tu­tional and reg­u­la­tory frame­work to en­able the con­vert­ibil­ity of the RMB, but no timetable was agreed.

Reg­u­la­tors will not risk un­der­min­ing the Chi­nese cur­rency for the sake of speedy re­forms, says Chen.“This is the tough­est re­form we have ever en­coun­tered. The cen­tral gov­ern­ment is clear that we must move to­wards fi­nan­cial lib­er­al­iza­tion, but re­forms will not be ac­cel­er­ated. In 2015, the global fi­nan­cial mar­ket is un­sta­ble, so we need to be cau­tious.”

Such ex­pla­na­tions have not sat­is­fied busi­ness, and at the end of 2014, fi­nance an­a­lysts openly crit­i­cized the zone’s slug­gish per­for­mance de­spite the im­ple­men­ta­tion of some pol­icy changes.

Last year, reg­u­la­tors lifted the ban on the cross-pool­ing of RMB, a liq­uid­ity mech­a­nism that en­ables for­eign in­vestors to move cap­i­tal be­tween on­shore sub­sidiaries to off­shore head­quar­ters via in­ter-com­pany loans.

Ad­di­tion­ally in 2014, the cen­tral gov­ern­ment opened the Shang­hai Gold Ex­change, an in­ter­na­tional trad­ing plat­form, in the zone. There are also plans to open eight more trad­ing plat­forms for gas/oil, iron ore, cot­ton, liq­uid, chem­i­cals, sil­ver, bulk com­modi­ties and non-fer­rous met­als this year.

This year also saw a sig­nif­i­cant en­large­ment of the Shang­hai FTZ to in­clude the city’s Lu­ji­azui fi­nan­cial dis­trict, where the city’s ma­jor multi­na­tion­als and Chi­nese banks have their head­quar­ters. In all the SHFTZ has nearly quadru­pled in size to en­com­pass nearly 47 square miles.

But as Tyldes­ley points out, the lack of a con­crete timetable con­tin­ues to dis­cour­age busi­nesses from get­ting in­volved.“This is sup­posed to be a three-year pi­lot, and we’re now half­way in. If they’re not go­ing to end it in 18 months’time, why not come out and say it? One of the big­gest costs to

Ini­tial teething prob­lems will prob­a­bly come in the form of bu­reau­cratic in­te­gra­tion

do­ing busi­ness any­where in the world is un­cer­tainty.” What does this all mean for Hong Kong? Ever since Shang­hai’s fi­nan­cial re­form am­bi­tions were an­nounced, Hong Kong-based fi­nan­cial ex­perts have been con­cerned about the city los­ing its long­stand­ing sta­tus as South­east Asia’s global trade and fi­nan­cial hub.

As the undis­puted win­dow to the sec­ond largest econ­omy in the world, the city of­fers for­eign in­vestors ac­cess to an in­ter­na­tional RMB trad­ing cen­ter.

Hong Kong ex­perts fear that if Shang­hai un­der­went lib­er­al­iza­tion poli­cies sim­i­lar to Hong Kong, the global fi­nan­cial cen­ter would lose its eco­nomic ad­van­tage and its fu­ture role in China’s in­ter­na­tion­al­iza­tion would be re­duced.

“Par­tic­u­larly af­ter the Oc­cupy Cen­tral move­ment, there is a fear that Chi­nese gov­ern­ment may try to de­lib­er­ately de­velop this par­tic­u­lar free-trade zone to re­place Hong Kong’s eco­nomic role,”says Wu.“By de­vel­op­ing an FTZ in Shang­hai, they could achieve their am­bi­tions more safely and re­li­ably.”

How­ever, in Main­land China, ex­perts be­hind the re­forms say there is lit­tle to be con­cerned about at this stage.

“Hong Kong has a very ma­ture eco­nomic and po­lit­i­cal sys­tem, and this can­not be achieved overnight. I think if we could even be as suc­cess­ful as Tokyo in years to come, we would con­sider that a great achieve­ment,”says Chen.

FTZ’s To Fol­low In 2015

Three more pi­lot free-trade zones were of­fi­cially launched in Fu­jian, Guang­dong and Tian­jin in April 2015. As in Shang­hai, for­eign com­pa­nies will be free to set up ven­tures with­out gov­ern­ment ap­proval, sub­ject to the neg­a­tive list, and will only need to re­port busi­ness plans to the author­i­ties.

In Guang­dong, the FTZ in­cludes the Nan­sha New Area, Shen­zhen Qian­hai and Zhuhai Hengqin New Area. In Tian­jin, the FTZ com­prises Tian­jin Port, Tian­jin air­port and Bin­hai New Area In­dus­trial Park. The Fu­jian FTZ cov­ers in­dus­trial ar­eas in the pro­vin­cial cap­i­tal of Fuzhou, the whole of Xi­a­men and Pingtan, and a new in­dus­trial park tar­get­ing in­vest­ment from Tai­wan.

Ini­tial teething prob­lems will prob­a­bly come in the form of lo­cal­ized bu­reau­cratic in­te­gra­tion. For ex­am­ple, the city of Fu­jian doesn’t have its own gov­ern­ment, so pro­vin­cial of­fi­cials will need to col­lab­o­rate on reg­u­la­tion.

“There could be in­ter­nal ad­min­is­tra­tive con­flicts,”agrees Chen.“The Guang­dong FTZ will in­clude Shen­zhen, which is di­rectly con­trolled by cen­tral gov­ern­ment rather than Guang­dong city, so this could throw up dif­fi­cul­ties.” BT

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