China: Has FTA snub driven Shanghai’s FTZ?

By:
Kanika Saigal
Published on:

Rush to open free trade zone; aim to facilitate China’s entry into TPP.

China’s launch of its first-ever free trade zone (FTZ) in Shanghai in September was widely taken as confirming its commitment to a more liberalized and open economy.

But some observers claim that the opening of the zone was more likely triggered by China’s absence from Trans-Pacific Partnership talks. The TPP is a US-led initiative building on a smaller free trade agreement that started in 2003 between Singapore, New Zealand and Chile. Now 12 countries are involved in the talks, including Canada, Japan, Malaysia, Mexico, Brunei, Australia, Peru, Vietnam and the US as well as the original three.

"It hasn’t been officially stated – Beijing wouldn’t dare – but I do believe that the TPP agreement and the fact that China hasn’t been involved in talks so far was the main trigger for the creation of the free trade zone," says a senior banker at an international bank in Shanghai. "China needs to be part of this relationship and cannot be left behind. It wouldn’t bode well to be excluded from a free trade agreement – especially at the same time China hopes to open up its economy on the national level. And it would be a reason why the zone was opened so quickly."

Global output

According to DBS Bank, together the TPP countries account for almost 40% of global output and about a third of global trade. The zone would be one of the largest free trade areas in the world.

Although South Korea, Taiwan and Thailand are considering joining, the world’s second-largest economy is strikingly missing from the list.

The TPP agreement aims to address issues including labour conditions, the role of state-owned enterprises, intellectual property and environmental protection. Lily Lo, economist at DBS Bank in Hong Kong, says only five of the 29 chapters that have been drafted cover traditional free trade matters such as the eradication of tariffs on goods and services.

A bigger concern lies with the rules of origin, says Lo. "It is likely that TPP countries will only offer lower tax rates for products using materials imported from member countries. Nonmembers such as China would be punished. China’s textiles and garment sectors stand to lose the most. [In a worst case situation] TPP members would refrain from engaging China in the textiles manufacturing process altogether."

TPP countries took 36% of China’s total exports in 2012, while an even larger percentage of its textile exports went to TPP countries. "The potential economic losses [for China, if they didn’t join] could be enormous," says Lo.

In this context, argues Lo, the FTZ in Shanghai and the speed with which it was set up – contrary to most slow and steady policy implementation in China – is most probably a response to deepening TPP negotiations.

Lo says: "Due to inherent differences in economic systems and political ideologies, China has in the past refused to conform to the rules of western institutions on key international issues. Likewise, the principles of TPP differ ideologically from China’s existing economic and political wirings. Yet with so much at stake, China might finally soften its stance and consider making some accommodations."

Qinwei Wang, China economist at Capital Economics based in London
Qinwei Wang, China economist at Capital Economics based in London
Timing

Qinwei Wang, China economist at Capital Economics based in London, also found the timing noteworthy: "After the details of the Third Plenum were published [at the end of the four-day meeting on November 12], it was plain to see China’s emphasis on liberalizing the service sector to seek greater international trade and to push competition and productivity – things that will bode well for China’s application to the TPP. Indeed, one of the key areas of the TPP was drawn on in China’s Third Plenum."

The creation of the new FTZ indicates dedication and unification among China’s central leadership to push forward with reform and the opening up of China’s traditionally closed economy.

FTZ

Financial and economic reforms in the Shanghai FTZ aim at facilitating freer trade and investment, currency convertibility, improving regulatory efficiency, as well as establishing a legal environment consistent with a market economy and international norms – and in line with certain requirements intended for the TPP agreement.

The geographically finite zone, split into four areas in Shanghai – Waigaoqiao free trade zone, the Waigaoqiao free trade logistics park, the Yangshan free trade port area and the Pudong airport comprehensive free trade zone – will become an offshore market for China on the mainland.

Follow on

The hope is that if these reforms prove to be successful, they will slowly but surely edge their way into national policy in China, or that even other FTZs will follow in Shanghai’s path.