China's New Free Trade Zones: A Pivot Inward?
October 23, 2020
By Joshua Henderson
Forty years ago, China established its first special economic zones (SEZs) as a key component of Deng Xiaoping’s “reform and opening-up (改革开放) agenda. Beijing created SEZs to attract foreign investment with tax and business incentives and they quickly became a hallmark of China’s economic liberalization and export-oriented growth model.
In 2013, China began experimenting with a new type of specialized SEZ: pilot Free Trade Zones (FTZs). Beyond operating as export-manufacturing areas with traditional fiscal incentives, pilot FTZs received targeted support from the central government focused on economic liberalization and investment policy experimentation. For example, China first tested its negative list approach to foreign investment in its Shanghai pilot FTZ in 2013. Thus far, FTZs have been an effective means of testing new economic policy under Xi Jinping and often forecast Beijing’s long-term policy objectives. FTZs also account for a significant portion of China’s foreign trade and investment. Through the first seven months of 2020, Chinese FTZs contributed $400 billion in foreign trade (13.5 percent of China’s total) and attracted more than 3,300 new foreign enterprises, accounting for $13.3 billion in foreign investment (16.8 percent of China’s total).
As China pivots away from export-manufacturing to a “dual circulation” strategy focused on domestic demand and technological self-sufficiency, FTZs are once again leading the way. China’s aspirational objectives to establish self-sufficient technology supply chains, become a global leader in the digital economy, and transition from low- to high-value-added manufacturing are apparent in the structure of China’s newest FTZs. On the other hand, the lack of practical measures taken to increase foreign access to China’s domestic consumer market indicates that Beijing may not be as eager to open-up its domestic economy as some policymakers have recently indicated.
On September 21, China’s State Council announced plans to establish three new pilot FTZs in Beijing, Hunan, and Anhui. In the announcement, Vice Commerce Minister Wang Shouwen said the new batch of pilot FTZs “demonstrat[es] the country's firm determination to accelerate the formation of a new development pattern through a higher level of opening-up”. While this “new development pattern” will become clearer as the new FTZs are constructed, initial plans indicate a heavy emphasis on technological innovation and supply chain restructuring.
The State Council heralded the Beijing FTZ as a major contributor to China’s technological innovation efforts. 25 percent of the 120 square kilometer zone will serve as a designated “science and technology innovation area” that will eventually host a “global startup innovation center.” Plans for the Beijing FTZ also reinforce China’s focus on digital payments innovation – local officials will work with the People’s Bank of China to establish a legal digital currency zone and digital finance system in the Beijing FTZ using a standardized system for digital asset exchange.
The Hunan and Anhui FTZs, while not as experimental as the Beijing FTZ, similarly aim to support technological development. Plans for the Hunan FTZ include the construction of advanced manufacturing clusters that produce high-end equipment, new generation information technology (IT), and non-ferrous metal processing. The Anhui FTZ will have an advanced manufacturing center for the production of integrated circuits, artificial intelligence, and financial technology (fintech) applications.
It is not surprising that Beijing seeks to expand China’s high-tech and advanced manufacturing capacity. Xi Jinping’s “dual-circulation” strategy emphasizes the need for technological self-reliance amidst deteriorating relations with the United States. Recent U.S. export restrictions on some of China’s largest tech companies have only reinforced Beijing’s drive to spur domestic industry and avoid reliance on foreign suppliers. The technological bent of the three new FTZs is not only in line with Beijing’s recent “strategic emerging industries” plan, but also provides a blueprint for how China might counter future disruptions to its international supply chains. Instead of pursuing bilateral or multilateral trade relationships in response to a potential U.S.-China decoupling, Beijing seems intent on incentivizing foreign and domestic firms to produce critical technologies and their requisite components domestically. This integration of the manufacturing process is a defining theme and “guiding ideology” behind the recent FTZ rollouts.
How China’s new FTZs promote “a higher level of opening-up” in the domestic economy is less clear. While plans for all three new FTZs encourage regionally “integrated development,” the proposed methods for achieving such integration (expedited customs clearance, centralized administrative licensing systems, and cross-regional benefit sharing mechanisms) do not represent the kind of needle-moving policy shift necessary to truly increase foreign access to the Chinese economy. Absent substantive market-access reforms for foreign enterprises, a focus on regionally integrated development in the new FTZs may actually reinforce Beijing’s long-standing preference for domestic champions, which will benefit from investment in regional economic integration while also enjoying exclusive full access to China’s domestic market.
The most promising proposal offered in China’s recent FTZ announcement is not the plans for three new FTZs but the expansion of China’s existing Zhejiang FTZ. Officials call for the establishment of “an international and domestic dual-circuit supply policy system for key components,” hinting at the possibility that foreign companies operating in the Zhejiang FTZ could be exempt from duties on “key components.” Such a change would be enormously impactful – current regulations exempt foreign companies operating in Chinese FTZs from duties when exporting goods and components but not when selling domestically. If a liberalized supply policy system like the one suggested for the Zhejiang FTZ comes to fruition, foreign access to China’s domestic market would be significantly increased for certain sectors.
Even if the Zhejiang reforms are successful, implementing such policy at scale will take years. It is possible, even likely, that China’s 14th five-year plan for social and economic development (released at the end of October) will outline a longer-term strategy for opening up China’s domestic consumer market to foreign investors. For the time being, however, that prospect still seems vague and distant. What has become clear, particularly in China’s new FTZ rollouts, is that domestic high-tech and advanced manufacturing production will be a defining feature of China’s economic agenda as it begins to implement Xi Jinping’s “dual circulation” strategy.
Joshua Henderson is a research intern with the Economics Program.
