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The latest hot topic in Chinese economic reform that people are seizing on a saving the hallowed 7.5% growth rate is the Shanghai Free Trade Zone (FTZ). It has been called a "game changer". Like many of the so called recent reforms, the Shanghai FTZ is little more than a retread of previous experiments that have not fared so well and ignore the primary problems.

The direct and near term economic impact is likely to be minimal, especially for the overall Chinese economy. The Shanghai area and surrounding counties are not large enough to impact the Chinese economy as a whole and as Shanghai is already one of the wealthiest areas in China, its marginal impact (i.e. above beyond the already significant benefits Shanghai has) are not likely to be large, especially in the short to medium term.

There are three additional reasons to believe the impact will be minimal. First, the size of the free trade zone is minimal at only 29 sq kms out of a Chinese landmass of 9.8 million square kms. To put that size in perspective, it is less than one-fifth the size of Washington DC and one-third the size of Manhattan. The Shanghai FTZ is too small to matter. Second, other FTZ have been tried here in Shenzhen, with little impact. Third, Shanghai was one of only two provinces in China to report GDP growth less than the national average. If this is the "game changer" China is hoping for, it might not be the type of game changer Beijing is hoping for.

With that said, the indirect impact and what this may signal have the potential to be enormous. There are three specific points here. First, Beijing has a long term strategy to reduce the influence and dependence of China on Hong Kong for finance and shipping specifically. This is another example of Beijing trying to reduce the influence of Hong Kong while increasing the profile and influence of Shanghai.

Second, Beijing is hoping to foster higher value added industries around Shanghai and move a higher amount of trade through Shanghai rather than the lower value added manufacturing and assembly that currently dominates the Pearl River Delta around Hong Kong. If the long term result is to foster greater creativity, entrepreneurship, and higher value added industries that are less reliant on fixed asset investment and low value added manufacturing, then the Shanghai Free trade Zone will be a success. Call me skeptical, but I doubt that a small FTZ will accomplish that and if it does it will take a long time to bear fruit.

Third, the Shanghai free trade zone is a classic example of a Beijing experiment to see if they want to expand similar policies throughout the country. Though details about what exactly the FTZ in Shanghai will mean, rumor and news reports appear to indicate it will be quite bold. As an example, Facebook and Twitter will be allowed as will easier RMB trading, which for China are all enormous shifts if true. Given the uncertainty about future economic policy and reforms, if this becomes the foundation for future policy it would be quite a signal. So far, the recent stabilization of the Chinese economy has depended on SOE's and fixed asset investment, rather than economic reform that will promote consumption which is not encouraging. However, if the Shanghai FTZ takes hold shifts a new direction in policy, it could herald quite positive things.

What is more difficult to ascertain is where this hastily announced FTZ fits within a long term policy plan or the more recent economic downturn. While there is a long term strategy to emphasize Shanghai at the expense of Hong Kong, this has the appearance of a hastily created plan. Given the size and haste, it is unlikely the Shanghai FTZ will have an impact on the current economic problems but will provide a good PR boost for those clinging to the reform led turnaround story. If I was to speculate, I would guess it was a plan probably floating in the background that received extra focus given economic struggles.

The primary impact of the FTZ will be if this is a test policy for nationwide changes and reforms of economic policy. If it is strictly limited to Shanghai and not even extended to surrounding provinces or the country, its impact could be quite minimal. If this is used as a test or ground work for greater nationwide reforms, it's impact could be quite significant. The Chinese government is feeling a lot of discontent within China and this is a way for them to test different policies. As a Chinese commenter noted once, why are we, North Korea, and Iran the only countries without Facebook. Nor is it any secret that economic freedom in China is about the same level of Facebook access. If these reforms take hold in Shanghai and spread, it could be enormous. I'm not holding my breath though.

Source: Some Thoughts On The Shanghai Free Trade Zone