WHEN it comes to China, Deng Xiaoping’s description of crossing “the river by feeling out the stones with our feet” has been widely repeated. The approach outlined by China’s former paramount leader and economic pioneer has held true. Ever since the country embarked on its journey toward economic liberalization, it has made small, incremental changes to its state-controlled economy. The government’s careful approach has allowed the Chinese to learn from the results of each fiscal and market experiment, before moving on to the next.

This pragmatism has been embodied in China’s approach to free trade zones. Currently, the country has six full-fledged zones and a number of lesser, more restricted zones. The former share a more free market status and operate under a more flexible regulatory regime, all aimed at fostering economic growth.

However, China’s latest and boldest economic trial, the China (Shanghai) Pilot Free Trade Zone, stands alone. Not only is the 28.75-square-kilometer area, the first true domestic free trade zone in China’s mainland, but it is also being used as a testing ground for two major pieces of reform.

The first involves loosening controls on foreign investment. In a highly symbolic move, the government has abolished the Foreign Investment Catalogue in the new zone. The catalogue, which explains where foreign investment is to be encouraged, restricted, prohibited or permitted, has been replaced by a simpler “negative list” of industry sectors.

The second reform is a large step toward financial liberalization. This involves far greater freedom in yuan convertibility, market-driven interest rates and the development of foreign-exchange settlement and reinsurance.

Chinese government officials, eager to keep the country’s economic growth on an upward trajectory, believe that the changes introduced into the zone can be replicated in other cities and then rolled out across the country. Essentially, the move to place a higher degree of freedom and self-responsibility on individuals and companies has transformed Shanghai into a new laboratory for economic alchemy.

But the zone goes beyond just a national testing ground. It also has been given the ambitious goal of helping Shanghai become one of the main financial centers in the world, taking over from Hong Kong and rivaling New York and London. This dual role opens up the possibility of a whole new wave of international business sweeping into the mainland through the port of Shanghai. It’s very good news for both China and foreign investors.

There have already been some very encouraging signs that the zone is on the right track. One, in particular, is the China Insurance Regulatory Commission’s decision to support the creation of new insurance company branches in Shanghai and aid development of cross-border yuan-denominated reinsurance. This latter move reduces the currency risk for Chinese reinsurers and boosts the role of the yuan. It also sends a message to the outside world. The Free Trade Zone really does mean business.

Marine insurance

This message has been reinforced by a large push for reform in marine insurance. As expected, given Shanghai’s position as the world’s biggest container seaport, this area has received much attention. Marine insurance operations centers and reinsurance companies in Shanghai can now set up sub-operations in the Free Trade Zone without requiring further approval. This business-friendly encouragement of innovation could well be replicated across other areas of insurance.

However, more can be done. China is right to be judicious and to exercise caution. After all, it is transforming itself from a rules-based economy to one potentially operating under a lightweight regulatory apparatus. But the pace of reform has prevented many foreign investors from moving into Shanghai. As of June this year, 10 percent of companies registered in the Free Trade Zone were foreign, which is indicative of the uncertainty surrounding how flexible the trading environment will eventually become within the area.

To make the most of Shanghai’s potential as a new breed of free trade zone, foreign companies should be given a clearer and broader framework that shows doing business in the Free Trade Zone is worthwhile. If that does not happen, there is a danger that Shanghai, like many other free trade zones in China, will end up building infrastructure but have no real foreign-invested trade flowing through it.

The speed at which further reforms are introduced becomes even more critical to the FTZ’s long-term prospects of success when you look around the region. Shanghai already has its fair share of competition, not only in Singapore and Hong Kong, but also in Labuan in Malaysia, Brunei Darussalam and Macao. This competition has its uses, however. It can provide China with some pointers as to how to further develop the zone.

Culture, as well as regulation, plays a huge part in the process of attracting foreign investment. Singapore has established the blueprint with its very successful free trading style. The fruits of an environment created by a buoyant and free culture are clear to see.

There is no reason why Shanghai cannot tap into China’s rich culture and history, adopt some of Singapore’s practices and further enhance its position as the physical and metaphorical gateway into China.

China would also do well to look at the outskirts of Western Europe to learn from another hugely successful free trade zone. Dublin’s International Financial Services Centre, set up in 1987, is today recognized as a leading base for financial services and a major focal point for the global reinsurance business. The city has become a lucrative source of tax income for the Irish government and contributes 7.4 percent to Ireland’s GDP.

The Irish government helped transform Dublin with two Finance Acts, one becoming law in 1986, and the other a year later. The first act introduced financial incentives to encourage urban renewal and investment by the private sector. Its 1987 successor established the now famous 10 percent corporate tax rate.

Although that rate has now risen to 12.5 percent, it still remains comparatively low and has enticed numerous giants in finance and insurance. Half of the world’s top 50 banks and half of the top 20 insurance companies now have a presence in the city.

Multi-layered network

As a result, Dublin has been named the freest Eurozone country in which to do business by the Heritage Foundation. Dublin has thrived, spawning a multi-layered support network for the big insurers and banks, including law and accountancy firms and other service providers. Looking at Dublin, the question the Chinese must ask themselves is: Do we have the same will to build up a whole international financial ecosystem of this kind?

Although there is still hesitancy on the part of the Chinese government to loosen the shackles from Shanghai, there have been suggestions that the authorities are ready to truly open up the free trade zone.

To capture the opportunities that such a move would unlock, Allianz and China Pacific Insurance Co have jointly decided to open the first office of our new CPIC Allianz Health Insurance joint venture in the Shanghai zone. If the approval process is straightforward, the new venture will open its doors by the end of this year.

Without doubt, the ability to run an international global alliance business out of the free trade zone, free of strict rules and regulations, is an opportunity that Allianz is eager to capture.

Shanghai is heading in the right direction, but in order to banish reticence among international companies, it needs to create a vehicle that allows companies not only do business out of China into the world, but to do business from everywhere around the world into China.