The Shanghai free trade zone (FTZ) commencement is set for September 29, and it will give Chinese policy makers the opportunity to experiment with deregulation and liberalization in one of the country’s most important economic regions. According to Societe Generale’s top China analyst Wei Yao, this shows that deregulation is coming sooner than most people expect, and could lead to surprises on the upside.

shanghai free trade zone

Development of Shanghai’s free-trade zone

“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,” says Yao. “The fast-track development of Shanghai’s free-trade zone (FTZ), firmly backed by top policymakers, is particularly encouraging.”

Yao explains that choosing Shanghai is culturally significant. It’s not just a strategically important city, it’s where former leader Deng Xiaoping established the Shengzhen Special Economic Zone, which was a precursor to opening up the economy in the 80’s and 90’s. Starting the process here is a way for current leadership to signal that it’s just as serious about deregulation.

“This is a development that can potentially bring positive surprises in the near future,” says Yao.

China should focus on service sectors

He argues that China should focus on its service sector, which is a much smaller proportion of GDP than in developed and some other emerging economies, normally more than 50 percent. Since China is facing serious oversupply in the manufacturing sector, shifting investment to deal with the under-supply of modern services is one efficient way to deal with slowing growth.

china modern service sector

The obvious way for China to accelerate service sector growth is through deregulation and de-monopolization,” says Yao. “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.”

Policies will be developed and implemented over the next year, but the starting point is promising. Restrictions on foreign investors and foreign ownership in the Shanghai FTZ will be almost completely lifted for the next three years. Monetary policy will be liberalized less quickly, partially out of concerns that changing them only in Shanghai could create arbitrage, but simply conservatism is probably also a factor.