Thursday, Oct 23, 2014, 11:21 PM CST – China

Special Report

Shanghai Free Trade Zone

Fourth Time’s the Charm

As China approaches its so-called “fourth openness surge,” care must be taken to ensure efforts are genuine

Photo by CFP

Lujiazui Financial City, on the east bank of the Huangpu River, Shanghai Photo by LI JIA

Shanghai’s historic Bund on the opposite shore Photo by LI JIA

A popular Chinese Internet meme devides the nation’s bachelors into diaosi (“losers”), and gao fu shuai – tall, rich and handsome. If China’s cities were in the dating market, its gao fu shuai would doubtless be its first-tier metropolises, with their sleek skyscrapers and high GDP per capita. Among these slick cities, Shanghai is undoubtedly Prince Charming – international high-end service business is an integral part of its past and present.

Along the Bund on the west side of the Huangpu River, international and Chinese banks dominate the Baroque and Gothic buildings which were built by Western banks after the gunboats of their home countries forced open China’s door at the beginning of the mid-19th century. By the early 1930s, Shanghai was known as the “Wall Street of the Far East.” Opposite the river are the avant-garde high-rises of Pudong New Area, home of more regional headquarters of multinationals than anywhere else in China. Foreign exchange rates are shown in some subway cars, and billboards of global stock exchange indices glitter at the crossroads of the Lujiazui Financial City, the heart of Pudong.

This is both the reason why Shanghai has repeatedly been chosen as the proving ground for further opening up of the country’s economy, and the cumulative result of these efforts over the years. In 1990, the late Chinese leader Deng Xiaoping decided to open Pudong to foreign investors to assuage their doubts over China’s seriousness about opening up after the Tian’anmen incident in 1989. From the very beginning, Shanghai’s opening up focused heavily on international finance and trading, regarded as sophisticated service businesses, a contrast to the sweatshops producing goods for foreign brands in the dozens of coastal cities that had opened to foreign business previously.

Over the past few years, China’s opening up process has rolled back. In addition, China has become a world plant, but no more than that. A new message that China is committed and able to restart the openness to march towards the high-end sector is necessary. Several cities were eager to be the messenger and test field. It came as no surprise that Shanghai – Prince Charm – won the race.

At the end of September, China’s first free trade zone was launched, amid much fanfare, on a 29-square-kilometer area within Pudong New Area, with deregulation of foreign investment in the long closed-off service sector, particularly international finance, high on the agenda. All pilot projects to be tested in the FTZ, if successful, will be rolled out around the country. It is expected that international assistance will lead China to become a real gao fu shuai in the global value chain.

Best of Times, Worst of Times

It was not until Deng Xiaoping declared Pudong officially open for business in 1990, and mandated bolder economic liberalization in 1992, that European, US and Japanese multinationals began to be a new important source of foreign direct investment (FDI) in China. China’s WTO accession in 2001 gave them more assurance. They regarded China as an attractive market from the very beginning, and localized some of their R&D and parts supply, rather than just their assembly lines. As a result, their investment has helped China build a fully-fledged supply chain, said Professor Wang Zhile, President of Beijing New Century Academy of Transnational Corporations. They were loved by the Chinese government and local white-collar workers – until 2006.

It was the end of the five-year grace period for China to honor its WTO commitments on tariff reduction and rule-making. The WTO review in 2006 noted that China’s remarkable trading reform had made China the world’s third largest trader, one of its largest FDI destinations, and had effected high economic growth and poverty alleviation. However, this had also led to “complacency over its track record and a lack of a new direction for the next steps,” as Professor Wang said to NewsChina. In addition, Chinese exporters were unhappy to find themselves the top target of anti-dumping tariffs by developed and developing country trading partners.

Skepticism about China’s openness prevailed. Long Yongtu, a retired senior Chinese official, was hailed in 2001 by the media as a national hero for leading China’s WTO accession negotiations, but discredited for the same reason five years later. A number of  acquisition attempts of big Chinese brands by foreign companies since 2006, from State-owned machinery giant SCMG to the privately-owned beverage maker Wahaha, were dubbed by some media as a “preemptive strike” against certain Chinese industries.

Those changes resonated in the international environment. Professor Wang highlighted that in the 1990s, the end of the Cold War resulted in a peaceful new dawn on the global market human history. Multinationals began to integrate resources globally, a process further facilitated by Internet-enabled communication and neoliberal economic globalization. Enterprises became “global companies” whose interests were intertwined with their host countries at least as much as, if not more than, their home countries. In the late 1990s, before China earned its WTO membership, US multinational giants, including Boeing and GE, lobbied hard in Congress to grant China most-favored nation status, making it a normal trading partner not subject to discrimination.

The 2008 financial crisis, an example of the potential pitfalls of neoliberal financial globalization, aggravated China’s complacency. Protectionism in trade and investment gained momentum around the world. Major international investors from the US were motivated either to return home as a response to the Obama administration’s “Reshoring Initiative,” or to move to other countries with cheaper costs than China. Western multinationals and politicians are now less enthusiastic about lobbying in favor of China than urging their governments to pressure China for more market access.

It is an open concern among Chinese analysts, including Professor Wang, that the golden age of openness may be long gone.

Backfire

The hesitance towards openness has already cost China’s potential growth in the innovation and service sectors. In its annual Position Paper released in September, the European Union Chamber of Commerce in China (EUCCC) complained that foreign companies are discriminated against in government subsidies for R&D projects and public procurement, in the name of protecting indigenous innovation. This has made European companies less motivated to bring their best technologies and R&D activities to China. European and American businesses have made such complaints repeatedly at least since 2007. It is a reluctance, not a rush, toward greater openness, said Professor Wang, that has hindered China’s efforts to move up the global value chain.

Because of restrictions on personnel and capital flow, Asia-Pacific headquarters of multinationals in China can only carry out low value-added services, while locating their high value-added services, like marketing and capital management, in Singapore or Hong Kong, according to Wang Xinkui, director of Shanghai municipal government’s counsellor office and a main architect of the Shanghai Free Trade Zone (FTZ), in an exclusive interview with the Chinese edition of NewsChina.

The reluctance will likely be costly. The service sector is now thought to play a bigger than ever role in world trade – in a report on the global value chain, the United Nations Conference on Trade and Development (UNCTAD) noted that “almost half (46 percent) of value added in exports is contributed by service-sector activities, as most manufacturing exports require services for their production.” As the global value chain is mainly coordinated by multinationals, added the UNCTAD, more FDI inflow generates more share of domestic added value in a country’s trade. Given that, the report stressed, most FDI promotion in countries around the world between 2003 and 2012 was related to the service sector.

Chinese Premier Li Keqiang disclosed in May at the Global Services Forum in Beijing that only 10 percent of China’s foreign trade is in services, compared with the world average of 20 percent. While low-skilled services like foot massage, hair washing and catering boom in China, those crucial for upgrading manufacturing, like design, finance, information, logistics and marketing, remain underdeveloped. Limited and expensive access to decent health care and education services has hampered consumption. All of those sectors are highly restricted to foreign investors.

In addition, the US is leading several regional free trade area (FTA) negotiations, including one with the European Union and another with Asia-Pacific countries. While the WTO is more about trade in goods, these talks focus on trade in services and investment. China is not part of these talks. Once those agreements become new international rules, many Chinese analysts and major State-owned media have warned, China will face “another difficult WTO-like accession process” to join the new international economic system.

Bang

The openness of the services sector and investment liberalization to foreign investment are the major goals of the Shanghai FTZ. Six service sectors are open to foreign investment in the Shanghai pilot project, including finance, shipping, telecom and gaming, professional services (construction, legal, engineering design, etc), entertainment, and social services. US and European companies are strong at all of these, and have long been eager to enter. For example, solely foreign funded health care institutions and credit rating companies are allowed.

More importantly, the way that foreign investment is administered has been improved. Under the existing system, a foreign investor has to check the long catalog that classifies a foreign investment as welcome, restricted or prohibited. Even a welcome business has to prove to various Chinese government agencies that it will be honest and beneficial, though it is up to the market, not any official, to decide whether it will be successful or not. A mountain of supporting documents must be prepared, such as application forms, business plans and credentials for capital sources.

The international practice in recent years has been to replace the long catalog with a much shorter list telling foreign investors which industries are closed to them, and any investment outside the so-called “negative list” will only file for their business, not applying for approvals. Nine rounds of negotiations between China and the US on a bilateral investment agreement made little progress because the US insisted the negative list be the foundation of any such agreement, a provision that China refused. At the fifth China-US Strategic and Economic Dialogue in July, China finally agreed to do this, and the two sides declared their intention to enter into “substantial” negotiations. In the same joint statement, China promised to test-run increased openness in the service sector and the “negative list” in the Shanghai FTZ.

National laws on the approval procedures for foreign investment have been suspended in Shanghai, followed by the publication of the first negative list at the end of September.

These changes were immediately hailed by nearly all Chinese media and analysts as the fourth openness surge following those in 1979, 1992 and 2001.

Appetizer

However, the list is widely thought to be a disappointing one, as it includes the majority of areas where foreign investment was previously unwelcome anyway. Observers are hoping the list is only a starter – the government has made it clear that the current draft is only the 2013 version and new, shorter versions will be forthcoming.

Andrea Nessi, Secretary General of the Swiss Chamber of Commerce in Shanghai, told NewsChina that Swiss banks have been looking forward to financial services liberalization in the Shanghai FTZ, but the list granted little freedom to set up foreign banks or bank branches. Swiss companies are usually cautious in making business decisions, he said.

Due to the complex and difficult process of getting approvals, most foreign banks rarely do real banking business in China, operating more like representative offices promoting their profile, such as sponsoring concerts or sports events. Mr Nessi has to use the Industrial and Commercial Bank of China, not UBS, a Swiss bank, for his payments in China.

Mixed feelings of disappointment with and appreciation for this first step, combined with a strong expectation of bolder steps to come, seem to be the prevailing sentiment in foreign companies. In a statement on October 8, the EUCCC described the replacement of the catalog with the negative list, a practice that they have long called for, as “a positive step forwards” which “could represent a potential breakthrough in China’s future management of foreign investment.” Several foreign banks, including Citibank and HSBC, have set up a presence in the FTZ. Mr Nessi, also an executive with Unitouch Services Shanghai, an international consultancy, is helping his Swiss clients follow the FTZ closely, to be well-prepared for upcoming business opportunities once the project’s full extent is known.

There is no guarantee that expectations will be met. At a forum on the Shanghai FTZ at Fudan University on October 13, Wang Xinkui explained why a low-quality list was made on the basis of the previous catalog. An important reason is that it would have taken too long to clear the many restrictive and conflicting market access policies that were entangled “like a bowl of noodles,” so the first step is to use the catalog as a reference so that the replacement of the approval system with a filing system can be realized immediately.

This explanation proved the extent to which the barriers to openness have been institutionalized, and thus difficult to remove. In his article in the Southern Metropolis Daily newspaper, Ma Yu, director of the foreign investment institute of the Chinese Academy of International Trade and Economic Cooperation, expressed his concern that the opening-up pilot to foreign companies in Shanghai would meet with the same failure as China’s efforts to give wider market access to Chinese private companies, a goal that has been repeatedly touted by the central government since 2005 but resisted successfully so far by vested interests, particularly government agencies holding approval power, and State-owned monopolies in those industries.

It is true that the new “negative list” model and filing system pave the way to what the EUCCC has labeled in its statement as a “level playing field” between Chinese- and foreign-funded firms. This, however, also means foreign investors still have to acquire industrial licenses if their industry happens to be restricted to their Chinese counterparts as well. Given the discrimination against the private sector in China, there is doubt about how much more business opportunity will be brought to foreign investors through the Shanghai pilot.

This suggests that the opening-up efforts in Shanghai cannot be ever be a complete success without domestic reform. Indeed, pushing forward reform is an even more important goal of the Shanghai project, and one that Chinese enterprises are looking forward to just as eagerly as their foreign counterparts.

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