Shanghai’s Proposed Free Trade Zone

The Chinese central government took what could be a bold step toward economic deregulation on Aug. 23 when the State Council officially approved the establishment of a free trade zone in Shanghai. The Shanghai zone will feature reforms not included in the special economic zones created in previous phases of Chinese economic development. It will seek not only to integrate four existing bonded trade areas into a unified tariff-free trade complex, but also to introduce substantial economic reforms within the zone's 28 square-kilometer (11 square-mile) jurisdiction. According to Xinhua, those reforms include nothing less than full interest rate liberalization, full yuan convertibility and significant relaxation of capital controls for businesses operating in the zone. In addition to promises to liberalize interest rates and reduce or remove restrictions on capital flows, the Shanghai zone will allow foreign commodities exchanges to set up bonded warehouses on the mainland, thus allowing Chinese and foreign commodities traders to cut costs by maintaining inventories domestically rather than in Singapore or South Korea. Other measures will reduce restrictions on foreign banks establishing branches within the Shanghai zone, encourage foreign direct investment into previously state-controlled sectors like health care and insurance and streamline customs procedures for imports and exports.

If fully implemented, these measures will make the Shanghai zone a testing ground for economic liberalization under China's current one-party system. In the short term, the Shanghai zone plan sends a strong signal to global markets that China's new leaders are serious about economic reform, and it provides a strong segue into the Third Plenum meetings in November, when the administration is expected to unveil major financial sector reform plans. More important, the announcement signals that Beijing understands that China's economic transformation is inexorable, and that as China's economy moves toward higher value-added industries, it will be forced to embrace greater global financial integration.