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Shanghai Mayor Defends Free Trade Zone

After China announced that Shanghai was set to be designated a free trade zone, the news was met with targeted criticism, rather than celebration, over the various restrictions attached to it. Now, Shanghai’s mayor has spoken out in defense of the plan while also acknowledging some of its flaws.

At least in principle, the point of the free-trade zone is to provide a region less bridled by China’s often cumbersome and complex business regulations, especially regarding the approval process for the receipt of outside capital.

However, almost immediately after the grand unveiling of the new free-trade zone, officially called the “China (Shanghai) Pilot Free Trade Zone,” the government also released a “negative list,” which enumerates all the regulatory restrictions on business that will remain in place. More specifically, the negative list catalogues all the industry areas that will still be insulated from foreign investment.

Yang Xiong, the mayor of Shanghai, tried to reassure critics that the rules were merely provisional while also carefully lowering expectations about their eventual scope. While many of the restrictions on trade may ultimately be lifted, those limiting the range of financial services will likely remain. He promised the “negative list will continue to be shortened,” and noted the cacophony of complaints from Western business interests. “One complain I’ve heard is that maybe it’s too long,” he said during a press conference.

The negative list expires at the conclusion of 2013 and then is open to revision. Since this list is a common topic between China and the U.S. during their current round of negotiations regarding an investment treaty, it is certain to become a bargaining chip for China. In fact, it may have been specifically formulated to allow China latitude to negotiate.

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The strictest provisions within the negative list involve realty, completely banning the building of villas in the zone by foreign companies. Frank Chen, executive director of CBRE Research, explains this prohibition as a means to control an unsettled real estate market. “The bottom line is: the government wants to avoid speculation in the property and land market. After the announcement of the free-trade zone, property prices in the surrounding area started to jump. They have to clamp down on speculation.”

The publishing of the list immediately sparked controversy. The length of the negative list surprised many, adducing more than 200 restrictions and running more than ten pages in length.

Some experts interpret the scope of the restrictions as evidence that China’s commitment to market liberalization is still tepid at best. Eswar Prasad, a China expert at Cornell University, said, “The list makes it clear that progress toward financial-sector and other reforms will be slow and grinding, even in this controlled environment.”

China’s central government quickly responded to the criticisms with hurried reassurances, noting that less than one-fifth of 1,069 economic sectors is covered by the negative list. A statement posted on the Chinese government website said, “From a detailed breakdown of industries on the negative list for the pilot Free Trade Zone, it is clear than China is sincere about opening up to foreign investment.”

Similarly, Tom Liu, chief executive at Chinascope Financial, Ltd., said, “The list is quite extensive but it doesn’t necessarily reflect the resolve to reform. It reflects the prudence with which the authorities want to begin this program.”

Others anticipated that list would be extensive and cautioned interpreting the amendments as a failure of commitment. Damon Paling, Partner at PricewaterhouseCoopers WMS Shanghai, said, “The initial negative list was in line with expectations and covers eighteen sectors including agriculture, manufacturing, finance and public services. What is important to note is that list is a temporary for 2013 and will change in 2014 as the accelerated liberalization continues,” in an email to the Sourcing Journal.

Paling continued to explain that the free-trade zone is intended to be an incremental unfurling of tight economic restrictions, largely managed by Shanghai’s local government. “Rather than being a “big bang” event a series of reform measures are to be released over the coming months and years. The government will control risks by adopting a step-by-step principle for rolling out these measures. The majority of the new rules and regulations to support business in the FTPZ are to be issued by the Shanghai municipal government,” he wrote.

The free trade zone had attracted considerable interest, apparently drawing more than 1.8 million visitors to its website already. However, uncertainty regarding the precise nature of the rules might slow down a similarly enthusiastic wave of new investment. Dennis McNally, global chairman of PricewaterhouseCoppers, said his firm was reluctant to commit immediately on these grounds. “We’re still trying to understand some of the specifics and details.”