Wednesday, Mar 29, 2017, 7:03 PM CST – China

Economy

Free Trade Zones

HELICOPTER PARENTING

Will more free trade zones help or hinder China’s efforts to stop local governments from luring investment with special treatment?

Customers at a duty-free shop in the Shanghai Free Trade Zone Photo by zhang peng

The maxim “Don’t let your children lose the race of life at the starting line,” all too familiar to Chinese parents, is often used to justify forcing children into advanced education ahead of their time. Chinese local officials, generally regarding local markets as their brainchildren, are equally competitive when vying for a head start – getting an early spot on the list for a trial reform project means earlier access to favorable fiscal treatment and the regulatory framework, and a better chance of winning the GDP race. Unsurprisingly, the “on your mark” call in the latest round of China’s ongoing reform has effectively set the competitors off at full pace.

On March 24, 2015, the central government approved three new free trade zones (FTZs) – in Fujian, Guangdong and Tianjin – as well as the expansion of the existing Shanghai FTZ established in October 2013. Aiming to promote business and liberalization of trade, these new FTZs are in line with the goal of this round of reform set by the Party: giving the market the “decisive role” in resource allocation.

While  this second lineup of FTZs have just hit their stride, would-be candidates for an as-yet unconfirmed third set are already warming up – Chongqing, Qingdao and Guangxi have submitted their respective applications to the State Council, and a number of others are preparing to follow suit. Analysts have warned that the outdated method of offering favorable policies is the cause of the fad, which even repeated proclamations from the central government that FTZs are about “reform dividends” rather than “favorable policy dividends” have failed to quell.

FTZ FoMO

In the detailed blueprints for the new and expanding FTZs disclosed on April 20,  2015, their geographic locations fitting into the strategic national economic landscape are highlighted: Tianjin will become the first free trade zone in China’s northern area, playing a crucial role in the economic integration of Beijing, Tianjin and underdeveloped Hebei Province. Fujian, the closest mainland province to Taiwan, will focus on cross-strait trade ties. Guangdong will ramp up her already lively economic cooperation with Hong Kong and Macao. The Shanghai FTZ will triple in size, making the city a test ground for international finance and a renewed thrust to prosperity along the  Yangtze River. These prospects, if realized, are also expected to serve China’s vision for the One Belt, One Road initiative,  linking Asia and Europe by both land and sea.

Besides their locations, the four (three new, one expanded) prospective FTZs’ relatively developed markets make them strong candidates. Within their collective borders lie nearly half of the first cities that opened to foreign capital in the early 1980s, where private and foreign investment enjoyed an array of favorable policies, particularly lower taxes and cheaper rent. This provided the boost for each city’s respective take-off, and each has been hailed as an example for the rest of the country to follow. As China pushes on with reform, the chance to be an early adopter of a certain trial project has become a feather in the cap of local governments, be it a hi-tech industry park, rural land exchange or financial deregulation. Rumors and clarifications about who has made the cut have been known to cause related stock prices to skyrocket or nosedive, a phenomenon described by investors as “map-based speculation.”

Unsurprisingly, underdeveloped areas are the most enthusiastic about joining the FTZ club by stressing their geographical importance. On March 31, 2015, the Sichuan provincial government announced its roadmap to establishing China’s first hinterland FTZ in Chengdu, which included a bevy of mega-projects in logistics, e-commerce, manufacture of autos and robotics, as well as investment promotion events in the US and Europe. The next day saw Wuhan, capital city of Hubei Province, attempt to accelerate their application process by applying Shanghai-inspired changes in their existing hi-tech parks sooner than the central government required. Hubei’s neighbors, Jiangxi, Anhui and Hunan provinces, all in central China along the Yangtze River, are considering a joint application with Wuhan. In the far-flung northwest, Ningxia, with the country’s largest population of Hui people, Chinese-speaking Muslims, is still awaiting the central government’s decision on its proposed FTZ with countries on the Arabian Peninsula. Inner Mongolia wants a border FTZ with Mongolia, while Heilongjiang has been preparing for one with Russia since late 2013.

Cloud of Doubt

Since the establishment of the Shanghai FTZ 18 months ago, free trade zones have been the subject of much debate. Before it can be considered for an FTZ-upgrade, a place is expected to have a certain standard of foreign trade, and the facilities that entails. Cheng Bo, secretary general of the FTZ Institute at Shanghai University of Finance and Economics has doubts about the feasibility of inland FTZs. “Foreign trade in a big city there can be dwarfed by that of a second-tier coastal city,” he told NewsChina. In addition, most places that have declared FTZ ambitions do not even have well-developed bonded zones, the basic infrastructure of any FTZ.

Given this, more doubts have been cast on what really lies behind the FTZ fever. The Shanghai FTZ is part of the central government’s plan to fuel stagnant reform using the pressure brought by openness, rather than a simple play to attract foreign investment, as previous special zones have been designed to do. The focus is on wider market access and less red tape, not favorable fiscal grants.

Immediately after the Shanghai FTZ launched, at least 20 cities and provinces immediately declared their plans to follow suit. In a June 2014 interview with Outlook Weekly, a magazine under the national Xinhua News Agency, Zhang Yansheng, secretary general of the academic committee of top macroeconomic planning body the National Development and Reform Commission, said many applications had little more value than “the old idea of building parks.”

The “parks” he referred to, be they “hi-tech parks,” “development zones,” or “industrial parks,” have mushroomed across the country over the past few decades. As Cheng Bo explained, most were designed to attract certain industries by offering fiscal or financial incentives, such as tax rebates and lower interest rates. Places with no such parks often use local public budgets to compensate enterprises as a disguised way of tax rebates.

“Many local governments still want dividends from the special policies granted by the central government, rather than the reform,” Cheng said.

Besides visible public money, whether granted by the central government or doled out from local public funds, local governments use a number of invisible – yet more important – tools as they compete to woo investors. In some places, large private companies paying more taxes have been put on local so-called “protection lists,” making them all but immune to local environmental, labor or food safety law enforcement agencies.

Another problem is a much-criticized recent phenomenon that media call “luxurious business promotion,” lavishing public money on five-star hotels and grand banquets for local officials’ investment promotion tours, particularly on the overseas market.

Out of Favor

It is now widely recognized that this method of soliciting investment using “special treatment,” and even the very concept of local governments focusing on investment promotion, are neither business-friendly nor in the public interest, and both have lost favor with investors and policymakers.

Most “parks,” whether self-styled or designated from on high, including those in areas with poor labor and infrastructure facilities, have been competing to attract similar industries, such as solar panels, biopharmaceuticals and animation. Enterprises lured by subsidized investment in those industries saw their businesses boom and bust rapidly. Some have ended up in the hands of property developers, or simply sitting idle. Since 2003, the Ministry of Land and Resources has had to launch a number of campaigns to recover misused or idle land in various industrial parks. Cases of enterprises on “protection lists” harming the local environment or ignoring labor laws are not rare.

For investors, these problems have taken the shine off of parks. Mats Harborn, vice president of the European Chamber of Commerce in China (EUCCC) told NewsChina that places providing better public services, fairer law enforcement and sustainable public financing are much more attractive than those offering special treatment. Chinese enterprises are increasingly inclined to agree, often finding their hosts ill-equipped to honor their promises, but keen to squeeze whatever benefit they can from the investor, often hampering operations. Those not on “protection lists” complain of unfair competition, even within the same area or park.

No Addiction, New Business

The central government apparently decided to kick away local officials’ special treatment crutch, and cure their obsession with investment promotion. In November 2014, the State Council ordered a stop to any illegal reduction of taxes and fees to local enterprises, to build a fair and open national market, a move widely regarded as the end of the era for many economic parks and zones. Despite very strong market expectations of favorable taxes and tariff policies in the Shanghai FTZ, none have ever materialized. In June 2014, the central government suspended reviews of any new FTZ applications to temper the FTZ fever, and approved the second batch of FTZs much later than expected. It has taken pains to emphasize that the FTZ project is all about reform, not gifts. In March 2015, a number of practices that have proven to work well in the Shanghai FTZ began to roll out throughout the country, focusing on streamlining corporate registration and operations.

In March 2015, Shanghai announced that governments in certain towns under its jurisdiction, including those in the newly extended FTZ areas, would not take any responsibility for attracting outside investment – focusing instead on providing better public services, the very reason for having a government in the first place.

Indeed, a shift toward public services can directly bring more tax revenue and jobs for local economies. While local officials have always tried to lure foreign companies into parks or zones, as Mats Harborn of the EUCCC explained, European investors see far more business opportunity in participating in improving the public facilities and services that originate from the growing demands of daily life in any society. At a press conference in Beijing on April 9, 2015, Harborn highlighted the interest of European companies in Beijing in turning waste, such as industrial sludge, into energy.

From the Top

This does not mean that the central government need only discipline recalcitrant local officials – change must also happen at the top. In March 2015, China’s Legislation Law was revised and the national legislative body took over the taxation legislation from administrative agencies, making it nigh impossible for the central government to grant special tax policies in future. Relevant laws and regulations were suspended under the approval of national and local legislation bodies before the Shanghai FTZ was in operation. This contrasted with the typical practice of China’s reform over the past decades, whereby the law was generally ignored in trial projects, and altered if the trial was a success. Now that an almost fully fledged legal system has been installed, respect for the law in any reform project has been made a priority. Responsibilities are scheduled to be redistributed between the central and local authorities by 2016, so that local governments have fiscal resources proportionate with their jobs. The Party’s HR department has declared new standards, with GDP rates given less weight, and social standards counting for more.

There are also doubts over the practice of testing reform policy in FTZs. “One can question perhaps whether China has come to the point where it would make sense, instead of creating special zones to develop new policies, to roll them out nationwide now,” said Mats Harborn.

Professor Feng Xingyuan with the Chinese Academy of Social Sciences has long been researching competition among Chinese local governments. He does not think it necessary to test policies like financial liberalization and red tape reduction in FTZs, as they have long since been proven to work well in market economies the world over. In addition, restricting this freedom to FTZs is unfair to other places in the country, he said.

Local governments are now eager to prove that they are transforming to “service-oriented” functions from investment-oriented ones, as required by the central government. While he believes it is good for local governments to compete in this regard, Professor Feng warned against a belief that the more services local governments provide, the better – the market and social forces should be at work. For example, public debate is necessary in growth planning. Business associations must be independent from the government. Products and services that can be provided by the market should be left to the private sector. These can only be made possible, he noted, by the Party’s commitments to more public participation in social governance, breaking off business associations from government agencies, and reform of State-owned enterprises.

In a wider sense, local economic growth models have long been regarded as part of national industrial policy. A number of cities have been designated as national demonstration bases for different sectors, including software outsourcing, modern agriculture and industrial upgrading. The central government has also announced plans to carry out regional economic integration. Professor Feng is concerned that these actions could disturb the flow of resources between markets in different areas. It is the responsibility of the central government, he stressed, to secure a unified, rule-based internal market where local governments have more autonomy and compete fairly. For example, local governments can decide local taxes within certain bands, but are not allowed to impose any discriminatory tariffs or restrictions on products from elsewhere.

Chinese parents have begun to realize that giving their children a so-called “head-start” is no guarantee of success, and may even be a hindrance. If Chinese governments can stop “helicopter-parenting” and take a hands-off approach, perhaps local markets will learn to play amongst themselves, and grow up stronger and more independent.

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