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September 30, 2013

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Home » Business » Finance Special

Business deregulation, finance liberalization are pluses for growth

By Yao Wei | September 30, 2013, Monday | Print Edition

Two forces are going to shape China’s economic future: deleveraging and reform. We’ve cautioned that deleveraging will be the biggest source of downside risk to growth in coming years. With regard to structural reform, the immediate impact is likely to be mixed. In our mind, deregulating the corporate sector and liberalizing the service industry are the key categories of reform capable of generating a positive boost in the near term. Hence, the fast-track development of Shanghai’s free trade zone, firmly backed by top policymakers, is particularly encouraging.

In order to understand the significance of this upcoming pilot project, one needs to look at the history of China’s reform and opening-up since 1978. Deng Xiaoping introduced market mechanisms via several flagship regional experiments. In particular, the establishment of the Shenzhen Special Economic Zone in 1980 re-opened the door to foreign direct investment. This Shenzhen model was adopted by a number of coastal cities from the mid-1980s. Aiming to rekindle investor confidence, Deng made his famous southern tour in 1992, reaffirming the Chinese government’s commitment to reform. One of the grand gestures following the tour was to grant Shanghai’s Pudong area a big package of pro-business policy, opening up to overseas investment to a greater extent.

The overarching theme of all the reform in the 1980s and 1990s was, simply put, liberalization. Local experiments in strategically important cities not only served as policy signals of reform commitment but provided guidance as to the path of upcoming changes. Fast-forwarding to now, the new leadership is forcefully pushing for another big package of corporate sector reform in Shanghai at a time when the Chinese economy is clearly at a critical juncture.

The Shanghai free trade zone was launched yesterday, which was just seven months after Premier Li Keqiang first openly endorsed the project. As summarized by the Ministry of Commerce, the purpose of the free trade zone is to explore paths for further business deregulation and opening-up of the service industry, as well as to test-run new ways of encouraging private investment. The framework that is shaping up looks rather promising, although details of most measures are to be put in place over the course of six months to one year. Moreover, like all previous economic experiments, this project is going to be a work in progress, subject to constant refinement.

The most significant measure confirmed so far is a three-year suspension of most of the current legal restrictions on foreign investment. Essentially, foreign investors will be able to invest nearly as freely as their domestic peers. Restrictions on foreign ownership are going to be abolished and the entry barriers will be lowered for the service industry, including finance, shipping, trade services, business services, entertainment and social services. Interest rate liberalization, currency convertibility and capital account liberalization seem to be taking a back seat in the experiment, at least in the initial stage. This actually makes sense and should not be regarded as a disappointment. Any financial market liberalization concerning capital flows and financial market prices, if implemented only in a certain geographic area of an economy, would lead to arbitrage opportunities and, more often than not, to financial market speculation.

However, we are not particularly worried about potential crowding out of foreign investment in other mainland cities or provinces as Shanghai’s free trade zone receives favorable policy targeting the service sector. Since services are non-tradeable, it is not necessarily a zero-sum game for Shanghai to get a head start in the development.

China’s service sector is certainly unrepresented in the economy, with its share of GDP notably lower than the norm of 55-60 percent among emerging as well as developed economies. The smaller share indicates under-supply of services in general, contrasting with the excess capacity problem of the manufacturing sector. Hence, shifting the focus toward the development of the service sector should help improve the efficiency of the economy as a whole.

Moreover, the gap in the share of modern services is even bigger, which suggests sizeable potential gains in productivity if China moves to catch up on that front. Another important merit of developing the service sector stems from its support to household income growth. For each unit of output, services on average hire more labor than manufacturing and the share of wages is higher. This explains the close correlation between the service share and the consumption share observed in many economies.

The obvious way for China to accelerate service sector growth is through deregulation and de-monopolization. State-owned enterprises have a disproportionally large presence in the service sector, accounting for one-third of the firms and three-quarters of jobs. For the manufacturing sector, the respective shares are just 2 percent and 12.5 percent. Besides, various surveys on the service sector have consistently shown that the No. 1 obstacle faced by private players is too much government interference. These are the exact issues that Shanghai’s pilot zone intends to tackle.

Initiating the experiment in Shanghai, a city of great strategic importance, is a clear sign that policymakers intend to push for economic liberalization nationwide quicker and sooner. This is a development that can potentially bring positive surprises in the near future.

 

Finance Special


 

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