Shanghai free trade zone won't thrive without all stakeholders on board
Chi Lo says local officials, interest groups have no reason to back reform
The launch of Shanghai's free trade zone has generated much excitement about accelerating China's structural reforms, capital account convertibility and internationalisation of the renminbi. Rhetoric and excitement aside, however, no one is asking the fundamental question of whether the incentives for the various stakeholders of the free trade zone are compatible.
This is the single most important issue in determining whether free trade zones can deepen China's structural reforms.
For the sake of systemic stability, fund flows between the free trade zones will not be fungible in the medium term; investment and business opportunities will be restricted to within each zone.
These conflicting interests have created a strong incentive for capital flight, the biggest obstacle
Other areas are expected to join the free-trade-zone queue. Arguably, these zones are the "financial cousins" of the special economic zones, which China set up in the early 1980s, and a natural next step up the value chain of economic reforms.
From a policy perspective, Beijing used special economic zones as a tool to build political and public support for reforms, and it is trying to replicate the success of that model, to revive economic vigour. However, things are not as simple today.
The incentives to reform the economy were aligned among all stakeholders of the special economic zones. Together with globalisation, they gave everyone a reason to focus on production and, hence, on getting rich by expanding China's aggregate demand through exports.
Economic interests were further cemented by an implicit social contract, struck between Beijing and the people following the 1989 Tiananmen incident, in which the party provided rising living standards in return for people not questioning its monopoly of power.