Shanghai trade zone misses on all points
By Michael Lelyveld
Economists are questioning the benefits of China's new free trade zone in Shanghai, despite rave reviews from the official press.
On September 27, the government outlined plans for the pilot free trade zone (FTZ), covering nearly 29 square kilometers (11 square miles) in the Shanghai area. Over the next three days, the official Xinhua news agency's English-language website posted no fewer than 14 stories, marking the opening of the FTZ on September 29.
Hailed as "the brainchild of Premier Li Keqiang" by state-run China Daily, the FTZ would serve as a laboratory for liberalizing the national economy, experimenting with eased trade, investment and monetary rules. Xinhua cited "global observers" as calling the
FTZ "the country's most significant reform push since the creation of the Shenzhen Special Economic Zone more than three decades ago".
Foreign commentary was more cautious and qualified.
"Whether the Shanghai zone will lead the way to broader changes depends on how much the government relaxes its controls," a New York Times editorial said, noting the government's outline included "few details".
On the surface, the government has pledged to allow free trade in currencies, fewer restrictions on investors and operations for foreign-owned banks.
But the outline is unclear about how much will be allowed and how soon.
"It's a hopeful sign, but there are questions about just how far it will go," said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington.
One of the biggest reforms promised for the FTZ is convertibility of the yuan on the capital account, meaning that China's money could be freely exchanged with foreign currencies for investment and asset flows. China already allows yuan convertibility for trade on its current account, but it restricts free exchange for investment, fearing loss of economic control.
The limits have led to disguised flows of "hot money" for speculation, producing huge exaggerations in China's trade figures earlier this year. The government has suggested giving capital account convertibility a tryout in Shanghai, but it is vague about when.
"Under the precondition that risk can be controlled, China will create conditions to test yuan convertibility under the capital account, market-set interest rates and cross-border use of the Chinese currency in the zone," said the outline.
Last May, the State Council called for an "operational plan" to achieve capital account convertibility, but no timeline has been set.
"The question will be, if they open the capital account in the zone, how do they keep that insulated from the rest of the country?" said Hufbauer. "Many people would say that's the whole point. You want a lot of leakage to the rest of the country."
The same kinds of questions surround FTZ plans for foreign-funded banks, private capital participation in the financial sector and access to investment opportunities in new areas of the economy. These could be big steps if they spread beyond the zone, but "if there's not much leakage, there's not much effect", Hufbauer said.
Derek Scissors, a resident scholar at the American Enterprise Institute, said the entire FTZ concept is flawed and not worth the official hype.
"The Shanghai Free Trade Zone just opened yesterday and I'm already sick of it," Scissors wrote in a September 30 blog posting. "It's not free, it may not emphasize trade, and there are questions about its function as a zone."
In an interview, Scissors challenged the FTZ's value as a stepping stone to national reforms.
"There are no conditions under which the FTZ as it stands is a good idea right now," said Scissors. "They're acting as if they can set up a financial zone, and have real liberalization and seal it off from the rest of the country. That will never work," he said.
Scissors sees the FTZ plan as the biggest promise that the government thinks it can make to reformers with the amount of political power that it has.
"This is a place-holder for real reform," he said. "It guarantees nothing, with at least a chance that something useful is going to come out of it."
One of the major selling points of the FTZ plan is that it takes a "negative list" approach to the kinds of foreign investment that will be allowed. Until now, opportunities have been open only in sectors on a positive list, leaving investors in the dark about what may be disallowed.
The new approach means investors "will have no need of government approval before setting up, so long as they formalize their arrangements after the fact, and do not operate in any sectors on a negative list," Xinhua said.
On September 30, the government published a 10-page negative list that may still leave investors in the dark. China Daily counted 18 main sectors with 1,067 sub-categories of business activity. Among the many restrictions noted by The Wall Street Journal, the government said investment in banks, financial companies and trust companies would be "limited", without giving details.
Strict prohibitions cover an odd assortment of activities, including news portals, Internet cafes, compulsory education, weapons, golf courses, auctions of cultural objects and "traditional Chinese tea processing techniques". Many other sectors are subject to limits that have yet to be defined.
Some foreign investment interests are encouraged by the hope that the negative list will be pared down over time, but that is also unclear.
China Daily called it the "first" negative list, leaving it uncertain as to whether there will be fewer prohibitions or more.
Scissors said the list offers little assurance of what the government calls "opening up".