What is the SEZ for exporters?

China

Mikko Huotari

Mikko Huotari is Deputy Director of MERICS and heads the International Relations program. His main research interests include China's foreign policy, Sino-European relations and the regional order in Asia. He has published numerous articles on China's global investment strategy and China's economic relations with Europe.

The PR China has been the "export world champion" since 2009, and foreign companies are closely linked with it despite the existing restrictions. While Beijing's leadership is committed to international economic integration, it reserves far-reaching internal economic interventions. Can this dual strategy be sustained in a globalized world in the long term?

China also owes its rapid industrialization to foreign know-how: Workers in a factory of the car manufacturer Ford in Chongqing (& copy Reuters / Shi Tou)

The weight of the Chinese economy in the world has increased rapidly since the beginning of the 21st century. For many countries - including Germany since 2016 - China is now the most important trading partner. The nature of the global interdependencies and the dependencies on the Chinese market are changing sometimes dramatically. The upswing and crises in China today have a direct impact on global market movements and economic prospects. Beijing's economic policy is becoming the central driving force behind global developments. At the same time, the Chinese leadership is confronted with ever greater challenges in reconciling market developments with political control claims and state control.

Success in catching up from 1978 to 2001

The largest economies - their economic performance in real comparison (2017) (& copy Bergmoser + Höller Verlag AG, figure 625 117; source: World Bank)
In the almost 40 years since the so-called reform and opening-up policy began in 1978, China's economy has moved from the periphery to the center of the world economy. Instead of less than two percent of global gross domestic product (GDP, adjusted for purchasing power) and a marginal role in global trade in 1980, the People's Republic now accounts for more than 18 percent of global GDP. By this measure, China is the world's largest economy, although it is expected to lag behind leading industrialized nations in terms of development for decades to come. In trade, the country has been the "export world champion" since 2009 and is now also the second largest importer. Its trade surplus, i.e. the value of exports versus the value of imports, was over $ 500 billion in 2016. (2017 according to Statista 421.44 billion)

Important factors for China's accelerated catch-up development, such as the gradual admission of market forces (i.e. supply and demand as the main drivers of market developments, release of prices) as well as competition, the mobilization of rural workers for industrial production or state-controlled investments are more likely to be located in the "interior" of China. Without a strategically controlled opening to the global economy, however, these factors would not have had their effect.

Above all, a rapid expansion of the export economy and foreign direct investment since the 1990s transformed China into today's trading state, which is integrated into global production networks and - since the dawn of the 2000s - increasingly also into global financial flows. Special economic zones as well as investments, technology and management expertise from abroad made accelerated industrialization possible, which initially affected the coastal regions in particular. Since China's accession to the World Trade Organization (WTO) in 2001, in particular, the country's foreign trade policy has pursued a gradual dismantling of trade barriers and other barriers in order to facilitate economic exchange with international actors.

Caricature (& copy Kai Felmy)
However, there can be no question of agreement with "liberal" ideas of an open market that is largely independent of economic governance. Despite the increasing weight of the private sector and although many branches of the Chinese economy are now being driven by intense market competition and are closely interwoven with the global economy, China's economic process remains characterized by a strong presence and diverse possibilities for intervention by government agencies.

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Phases of the opening policy from 1978 to 2001

1978–1986 / 87 import substitution and establishment of special economic zones (SEZ)
Targeted increase in the price and shortage of foreign products and an increase in the number of products permitted for foreign trade
Settlement of foreign investors in privileged special economic zones in southern China and other coastal cities
Opening up to foreign loans, including the World Bank and the International Monetary Fund

1987–1992 In-depth export orientation, use of competitive advantages in labor-intensive production
Target agreements with additional incentives for companies in foreign trade
Transformation of the entire coastal region into an outward-oriented economic region (Hainan as the fifth special economic zone, promotion of the export economy and growing foreign direct investment, especially from Hong Kong and Taiwan)
Gradual devaluation of the currency makes Chinese goods cheaper abroad

1992–2001 expansion of the opening-up policy before joining the WTO
Supplementation of the export orientation through import substitution policy for selected industries in order to cushion the competitive shocks of opening up to domestic industries.
Targeted promotion and protection of selected industries through foreign direct investments and high import tariffs
Industry guidelines for managing the skyrocketing foreign direct investment and further expansion of foreign trade rights

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Waymarks since 2001

The focus and the type of state intervention with which China's external economic integration is controlled has shifted steadily since the end of economic isolation in 1978/79. The three most striking milestones for China's role change in the global economy of the 21st century are the effects of WTO accession in 2001, the handling of the global financial crisis in 2008 and the realignment of economic policy under Xi Jinping since 2013.

Accession to the WTO
WTO accession on December 11, 2001 had profound effects on China's economic development and on the framework for economic governance for the leadership in Beijing. The necessary adjustments to the domestic economy went far beyond the dismantling of customs barriers for the import of foreign goods, which had largely already taken place in the run-up to accession.

Between 2001 and 2007, further liberalization steps in foreign trade and the opening up of further sectors for foreign investment, especially in the service sector, were contractually stipulated by joining the WTO. Despite all the remaining restrictions, WTO member China became one of the most open economies: In the period from 2004 to 2008, the foreign trade quota - the share of exports and imports in GDP - was more than 60 percent, currently still over 30 percent. The reform steps in this phase, however, went far beyond trade. They also included international IPOs of state-owned companies, an easing of capital movements through a limited opening of the banking and bond markets (for foreign companies), the adjustment of the exchange rate regime (from a "fixed", i.e. secured by state intervention, to an increasingly flexible exchange rate ) as well as an ambitious promotion of foreign investment by Chinese companies.

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China's role in the WTO

Joining the World Trade Organization (WTO) in 2001 accelerated China's integration into the world economy and the promotion of competition and deregulation in the Chinese domestic economy. In addition to necessary liberalization steps, accession to the WTO is also connected with the obligation to recognize the authority of the institution in trade disputes. In the case of China, disputes typically concern allegations of price dumping and subsidization of Chinese exporters as well as discrimination against foreign competitors. China's extensive adaptation to WTO regulations is generally recognized. Although the People's Republic continues to be one of the most frequent defendants in WTO proceedings, it is also increasingly using the WTO's instruments itself.

After a 15-year period, the last transitional regulations from China's WTO accession protocol expired on December 12, 2016. Beijing expected that the People's Republic would have to be finally recognized internationally as a "market economy" - which would have the consequence that Chinese companies could no longer be complained so easily in anti-dumping proceedings. In the summer of 2017, however, several large industrialized countries had not yet taken this step, although Beijing had in the meantime initiated legal proceedings in this regard at the WTO.

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Reactions to the global financial crisis 2007/2008
The global financial crisis of 2007/2008 did not immediately impact the banking and securities sector in China, as the Chinese financial system was protected from the most violent turbulence in global financial markets by strict capital controls. Instead, the crisis affected the real economic trade channels: the decline in international demand caused Chinese export and growth figures to collapse.

The central government announced an economic stimulus program consisting primarily of loans for infrastructure projects - amounting to around 13 percent of GDP - in order to achieve its growth targets and prevent mass layoffs in the export industry. In terms of foreign trade, the Chinese currency was pegged more closely to the US dollar again for two years in order to ensure stability. Export firms were also supported by tax breaks and loans, and domestic industry was given preference in government tenders.

From the perspective of the Chinese leadership, the 2008 crisis revealed the weaknesses of "neoliberal" opening policies. According to Beijing, it is important not to surrender the macroeconomic control and intervention options. This includes a state corporate and investment policy and external adjustment screws such as exchange rate and capital controls. It must be possible to suspend liberalization steps or even remain reversible.
China's state investment boom to overcome the crisis since 2008 and its active, wide-ranging industrial policy have boosted international demand and helped stabilize the global economy. But the measures chosen to combat the crisis have exacerbated debt and delayed the planned structural reforms. To this day, these aftermaths form the background for faltering reform efforts and hesitant efforts towards deeper global economic integration.

Balancing act between openness and control
The resolutions of the third ZK plenum in November 2013 to reorganize the Chinese domestic economic model have far-reaching consequences for the country's external economic integration. The aim of the consolidation of state-owned companies in strategically important industries, which has been intensified since 2015, is to create competitive national champions who are to expand internationally.

Since 2013, concrete, albeit hesitant, steps have been taken to deepen the "opening policy" in trade and, with regard to foreign direct investment, there has been a cautious relaxation of capital controls and exchange rate policy. As part of new experiments with "free trade zones" (FTZ) - initially in Shanghai, then expanded to a total of eleven FTZs in 2017 - some investment restrictions have been gradually lifted and administrative processes have been simplified. Foreign investment legislation has become more reliable and further simplified with the establishment of a nationwide "negative list" (i.e. restrictions only through explicit listing) in July 2018.

Despite these selective measures, the market opening is only creeping up. So far, it has mainly been limited to rather unattractive economic sectors or those in which Chinese companies have already dominated the market due to years of isolation. In contrast, the service sector has not yet been fully opened up. From the point of view of foreign economic actors, China is thus falling short of its 2013 reform promises.
On the contrary, Beijing has tightened the screws in many areas - especially for high-tech companies - withdrawing previous privileges for foreign companies and making it difficult for them to enter the market in practice. Furthermore, informal and formal discriminatory measures determine the economic activity of international companies in China.

Given the signs of a slowdown in Chinese growth, especially since 2015, the leadership in Beijing is attempting a difficult balancing act between increasing opening up to international capital movements, maintaining a relatively stable exchange rate and the ability to control the domestic economy. In order to attract new sources of finance for domestic companies, Beijing experimented with further reform steps in the financial sector, including in the Shanghai free trade zone, but above all by further controlled opening of the securities markets to international investors ("Stock-Connect" 2014 and "Bond-Connect" 2017 with Hong Kong).

Acute crises have repeatedly led to the reversal of earlier reform steps. Between 2005 and 2014, the Chinese currency, the renminbi (RMB), appreciated by almost 40 percent in real terms against the US dollar. However, after a drastic crash on the Chinese stock exchanges in the summer of 2015 and massive, often hidden outflows of capital abroad, the renminbi was significantly devalued. Even the introduction of a more flexible exchange rate regime in winter 2015 could not alleviate the downward pressure. The central bank had to brace itself against ongoing capital outflows and a devaluation of the RMB through the concentrated use of currency reserves.