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Testing the Waters

Shanghai is expected to lead a ‘stress test’ for China’s further opening-up, and of the country’s capacity to take the helm of globalization

By NewsChina Updated Feb.1

Free trade may be losing popularity in many places around the world but in China it’s in vogue. Shanghai leads the craze, as the city – probably China’s most cosmopolitan – has always pursued fashionable trends, whether in lifestyle or economics. The construction of “free trade ports” was enshrined at the 19th National Congress of the Communist Party of China, which was convened in October 2017. As a result, a number of Chinese provinces are competing to host a port. So far, Shanghai’s ambitions have been the only ones endorsed, or indeed designated, by the central government.
On January 4, 2018, the Shanghai municipal government unveiled its Master Plan 2017 – 2035, with a vision for “an excellent global city.” The blueprint, approved by China’s central government two weeks earlier, includes a planned free trade port that would help the city upgrade to an “international hub for economics, finance, trade and shipping” by 2020. 
Before this, Shanghai tested the waters with a free trade zone in 2013. This was part of China’s effort to further advance economic reform – a strategy earlier proven effective by China’s endeavors to join the World Trade Organization in the 1990s. Many trial programs that originated in Shanghai, including cutting red tape for businesses, have been promoted in 10 other free trade zones since. 
The free trade port is expected to be much more open than existing free trade zones. In an article for the Chinese Community Party mouthpiece the People’s Daily on November 10, 2017, Chinese Vice Premier Wang Yang used the examples of Hong Kong, Singapore, Rotterdam and Dubai to define free trade ports as “special economic function areas with the world’s highest level of openness.” 
Details of the plan for the free trade port in Shanghai, most likely China’s first, are yet to be disclosed. One thing is clear: It will act as a “stress test” for China’s opening up in the coming years. 

Dual Track 

Various special economic zones, industrial and hi-tech parks – under different names – have spearheaded China’s Reform and Opening-up process for decades. They have typically offered favorable tax and land policies to Chinese and foreign investors. This treatment was not on the menu for the trial free trade zones (FTZ) that began in Shanghai in September 2013 and then spread to 10 other cities at different development levels. Instead, Reform and Opening-up are the top priority. Each FTZ has a different main task. One in Zhejiang Province on China’s east coast will become a center for fuel oil shipping and refining, and for foreign trade. Chongqing Municipality in the southwest will seek opportunities from the Belt and Road Initiative and the growth of the inland region along the Yangtze River. 
Hundreds of measures first adopted in the Shanghai FTZ have become commonplace in other similar areas. Sometimes they have even become national standards to save businesses time and money by cutting down on red tape, according to Shanghai municipal government officials at press conferences in April and September 2017. For example, importers and exporters now declare their goods at a one-stop desk at customs, rather than dealing with dozens of desks as they did before. In the Shanghai FTZ, this is estimated to have saved companies around US$300 million in 2016.
The most high-profile reform has been the introduction of a negative list for foreign investment. Foreign investment in China is grouped into four categories, ranging from forbidden and restricted to permitted and encouraged. The category is updated once a few years. In the Shanghai FTZ, these categories have been replaced by a negative list, which is regarded as part of the preparation for negotiations between China and the US on a bilateral investment treaty. Foreign investors no longer have to go through an approval process to incorporate a company in Shanghai FTZ as long as its business line is not on the negative list. China has shortened the list since then. Right now, a fifth of companies in Shanghai FTZ are foreign-funded, up from only five percent four years ago when the FTZ began. 
There has been limited progress in Reform and Opening-up of the service sector, particularly in finance. Practices used in FTZs are expected to be promoted nationwide, but at the same time, potential risks that could be brought about by greater openness in those zones must be prevented. “This is a conundrum. Reform means risk-taking, but concerns over potential risks constrain process and slow the pace of reform. Meanwhile, it is time for China to participate in the global competition for the allocation of market resources,” said Chen Bo, executive director of the Free Trade Zone Research Center at Huazhong University of Science and Technology in Wuhan, Hubei Province. 
Chen believes the solution is to move the two fronts at the same time. “FTZs should continue to try reform policies that can eventually be promoted around the country, while free trade ports are supposed to adopt the best practices of the most open economies in the world to be a direct player in global competition,” he explained to NewsChina.  

Free Flow 

At the end of March 2017, China’s State Council, the nation’s cabinet, decreed reform and opening up in the Shanghai FTZ should go even further. The key is to establish wider market access to domestic and international investors and more efficient regulatory frameworks for doing business, including foreign trade. On January 9, 2018, the State Council declared it would relax restrictions on foreign investment in the existing 11 FTZs in a number of sectors, including banking, international shipping, entertainment and urban rail equipment manufacturing. 
The April 2017 announcement makes it clear that a free trade port will be built at the Yangshan Deep Water Port and Pudong airport in Shanghai. This is a part of the “stress test” to pave the way for adopting international standards for the most open economic system. The standards will cover customs declarations, finance, foreign exchange, investment and border control. Currently, Yangshan Port deals with a higher volume of containers than any other port in the world, and Pudong airport records the third-largest cargo volume in the world. 
Yu Miaojie, a professor with the National School of Development at Peking University, told NewsChina a free trade port typically exists outside customs within the border of the host economy. Hong Kong and Singapore are examples that the proposed Shanghai Free Trade Port can learn from. Very few tariff or non-tariff barriers are imposed there. According to a study by the Chinese Academy of International Economy and Trade Cooperation in 2014, the import and export of certain goods, including those for transfer to other destinations or posted under a certain value, do not have to be declared at Hong Kong customs in advance. In the current FTZ and bonded areas in the Chinese mainland, including Shanghai, the unpacking and rearranging of containers must be reported to and supervised by customs. Such reporting and checking is normally not necessary at a free trade port, according to Zhao Nan, director of the Port Development Department at the Shanghai International Shipping Institute. She gave another example – the maintenance of internationally operated freight vessels. Some parts have to be imported and then exported to the vessels to replace the old ones. This takes time and money. Zhao thinks this process can be much faster and shorter if done at the free trade port in the future. 
A September 2017 working paper led by Yu observes three main gaps between existing FTZs in the Chinese mainland and two other free trade ports in Asia, Singapore and South Korea’s Busan. It suggests that a nationwide integrated customs declaration system be installed to facilitate one-stop service at free trade ports. It also calls for more attractive conditions to bring in high-end foreign talent and more open cross-border capital flow there.  


Analysts hope this high-level free flow of goods, capital and people will spur the development of international high-end services for offshore trade and finance, as existing international free trade ports typically do. For example, many trade firms in Hong Kong provide purchasing, marketing, logistics, financing and customs documentation for importers and exporters beyond Hong Kong. In 2015, they dealt with US$556 billion worth of such trade, according to the Hong Kong Trade Development Council. Some of the goods do not even pass through Hong Kong.
If similar businesses are developed in the planned Shanghai free trade port, the financing and trade settlement involved in the process will be a starting point for international finance operations. Many Chinese analysts, including Yu, think these services will set the free trade port apart from China’s existing FTZs. 
Chen Bo believes a free trade port will also bring opportunities for two types of multinational businesses. One is international shipping and the other is multinational headquarters that finance and allocate capital for other companies.
The question of how to properly regulate them remains. For example, in his visit to some existing free trade zones, Bai Ming with the Chinese Academy of International Trade and Economic Cooperation found couriers were not even allowed to bring in takeaway food. In the meantime, there is not much discussion about how to prevent possible spillover shocks to border control outside the free trade port. Chen Bo thinks this concern is part of the reason why the master plan of the Shanghai Free Trade Port has yet to be decided by the central government. There is a consensus that the key is to improve the capacity of regulators to do their job, not to impose stricter controls. 
There is another possible spillover risk. Tariff rates at Hong Kong and Singapore customs are very low or even zero for most goods. Smuggling is not attractive. 
Imports do not threaten domestic industries. This is not the case for the Chinese mainland. The very low or even zero tariffs at the free trade port in the future could expose domestic industries to competition with much cheaper imports – legal and illegal – said Chen in an interview with the 21st Century Business Herald newspaper published on October 26.
But Yu does not think the potential risk of spillover from free trade ports will be the biggest problem. Instead he stresses the importance of researching each location that voices a strong desire to establish such a port, ensuring only those with a strong and open infrastructure and market can be enlisted. 
Shanghai will face many obstacles before it can once again take up the mantle as a testing ground for Chinese economic reform. Shanghai’s venture will also be a “stress test” for China’s vision of becoming the leader of globalization.