One Belt and One Road and Free Trade Zones China s New Opening-up Initiatives 1

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1 Front. Econ. China 2015, 10(4): DOI /s OPINION ARTICLE Justin Yifu Lin One Belt and One Road and Free Trade Zones China s New Opening-up Initiatives 1 Abstract One Belt and One Road and Free Trade Zones are two of China s new opening-up strategies developed in response to the changed domestic and international circumstances. Implementation of these strategies can provide China with a sounder market economic system and a better external environment. It can not only help China to further develop into a high income country, but also facilitate the industrialization and modernization of other developing countries. Keywords Chinese economy, free trade zone (FTZ), One Belt and One Road JEL Classification O24, F63 China began its transition from a planned economy to a market economy in Over the past 36 years, it has witnessed an average annual GDP growth rate of 9.7% and an average annual trade growth rate of 16.4%. In 2009, China, with its GDP surpassing that of Japan, became the world s second largest economy. In 2010, China overtook Germany in export volume and thus became the world s largest exporter. In 2013, China surpassed the US in total volume of import and export trade, and became the world s largest trading country. In 2014, China became the world s largest economy as she overtook the US in overall economic scale, measured by purchasing power parity. China s achievements since reform and opening-up can be described as an unprecedented miracle in world economic 1 Editor s Note: This article is based on a speech at the Free Trade Zones and New Openness in China Summit Forum organized by the School of International Business Administration, Shanghai University of Finance and Economics on May 15, To stimulate discussions and research, this journal periodically publishes opinions written by economists on issues related to China and other transition or emerging economies. The views expressed here are those of the author and do not necessarily reflect those of this journal. Received June 23, 2015 Justin Yifu Lin ( ) National School of Development, Peking University, Beijing , China

2 586 Justin Yifu Lin history. Why have the former Soviet Union and Eastern European countries suffered economic collapses, stagnation and unceasing crises in the transition process while China has been so successful? Most importantly, China did not take the mainstream Washington Consensus shock therapy, which was intended to remove all interventions and distortions simultaneously and immediately. Instead, China adopted a pragmatic, gradual, dual-track approach. In the early years of reform and opening-up, China had a large number of state-owned enterprises in capital and technology intensive industries. Lacking comparative advantages, such industries would have been unviable if left to the open and competitive market, and would not have survived without protection and subsidies. Therefore, during the transition period, the government provided necessary protection and subsidies for these enterprises while opening-up the labor intensive industries which had comparative advantages but were traditionally repressed. Such dual-track reforms allowed China to maintain stability and achieve rapid growth at the same time. A similar strategy was applied to opening-up. For technology and capital intensive industries which consisted mainly of state-owned enterprises and which in general defied comparative advantages, China continued to provide necessary protection and restrict the foreign investments. While labor intensive industries with comparative advantages were opened up and proactively attracted foreign businesses and investment, in addition to encouraging domestic investment and fair competition. Back then, China s capital market was undeveloped and its financial system rather backward. Hence, China exercised management and control over capital account for short-term flows of capital, but China was relaxed with regard to current accounts for flows of goods and direct investment of foreign capital. Such a pragmatic, dual-track transition enabled China to achieve stability and rapid growth. However, it came at a cost, as market interventions and distortions gave rise to rent seeking, corruption, inequitable income distribution and other problems. In the 1980s and 1990s, the early stage of reform and opening-up, China was a poor and backward nation with no comparative advantages in capital-intensive industries; at that time it was a low income country with a GDP per capital less than one third of the average GDP for African nations. After more than thirty years of rapid growth, China has become an upper-middle income country whose

3 One Belt and One Road and Free Trade Zones 587 GDP per capita has reached USD 7,600 in 2014, with comparative advantages in some capital-intensive industries such as automobile, machine-building, steelmaking and aluminum metallurgy. In the early stage of the reform, China was a low-income country. It was essential to provide protection and subsidies for unviable firms in comparative advantage-defying industries, which contributed to the economic stability. If this favorable policy continues when these industries have become China s comparative advantages and firms in these industries viable in an open and competitive market, it certainly benefits these firms; but it will also lead to widespread rent-seeking and inequitable income distribution. Hence, the Third Plenary Session of the 18th Central Committee of the CPC proposed to deepen reforms in an all-round way, remove all distortions left over from the dual-track transition, and allow the market to play a decisive role in pricing and resources allocation. A similar deepening reform also applies to opening-up. In the early stage of opening-up, in order to protect some industries without comparative advantages and maintain financial stability, foreign investment was limited in many fields and capital account was controlled. So deepening reform means both internal deepening and deepening of opening-up. The proposition of the free trade zone (FTZ) initiative is to explore how to remove those limitations on investment in all fields except for a few that are really related to national defense and security and thus require necessary control. Meanwhile, capital accounts should be liberalized to allow free capital flow. To push these reforms forward, China follows a pragmatic approach again. For instance, China will carry out pilot projects in some areas to first see its effects, expand those pilot projects with positive results to more areas or even nationwide, and prevent negative effects from spreading beyond the pilot zones. Under such an approach, the Shanghai FTZ was established, followed by those in Tianjin, Guangdong and Fujian. Why was the Overland and Maritime Silk Road Initiative or the One Belt and One Road (OBOR) strategy proposed? After 36 years of reform and opening-up, China has grown to be an upper-middle income country. For the sake of the great national renaissance, China hopes to overcome the middle-income trap and develop into a high income country. Judging from the experiences of reform and opening-up, China should make the best of markets and resources at home and abroad. Besides, China is now the world s largest trading country, the world s

4 588 Justin Yifu Lin second largest economy in terms of market exchange rate and the world s largest economy in terms of purchasing power parity. So internationally, China should assume commeasurable responsibilities and have the corresponding influence and voice in determining international affairs and rules. The above change is consistent with the historical experiences of international economic and political development. However, US-led developed countries after World War II made the current international order in favor of their own interests. In view of considerable changes in the global situation, if China is required to undertake more obligations, it should be given a bigger voice. In that regard there is international consensus. In 2009, President Hu Jintao reached an agreement with President Obama at the G20 Summit to increase China s voting power in the World Bank and International Monetary Fund. However, the agreement was denied by the United States Congress. Also, to maintain its benefits in the Asia-Pacific region, the United States proposed the strategy of Returning to the Asia-Pacific and Rebalancing to the Asia-Pacific. Furthermore, in the US-led negotiations of Trans-Pacific International Partnership, China, the world s largest trading country, was not invited to participate. Obviously, it reflects the intention of the US to maintain its strategic advantages in the Asia-Pacific region and to ensure its geopolitical and geoeconomic interests. Similar to what happened during the rise of Qin State in China s Warring States Period more than 2000 years ago, the US adopts a strategy of vertical alliance (uniting the neighboring states in China s east) to contain China s development. In such a situation, President Xi Jinping proposed to co-build the Silk Road Economic Belt during a visit to Kazakhstan in September In October of the same year, he proposed the initiative of the 21st Century Maritime Silk Road in Indonesia during a visit to the ASEAN. The initiatives were aimed at establishing a regional cooperation framework from east to west, across Asia to Africa and Europe for the purpose of policy communication, road connectivity, unimpeded trade, currency circulation and friendship building and the building of a community of common interest, destiny and responsibility for countries along the OBOR. The initiative, based on infrastructure construction, has contributed to the establishment of the Asian Infrastructure Investment Bank. The Asia-Pacific region was in need of infrastructure construction, of which the US was well aware. At the time it put forward the Returning to the Asia-Pacific strategy, the US also proposed building the Indo-Pacific Economic

5 One Belt and One Road and Free Trade Zones 589 Corridor and the New Silk Road connecting Afghanistan and Central Asian countries, which have got nowhere so far. But the Asian Infrastructure Investment Bank, proposed by China to promote the OBOR initiative, has 57 founding countries from five continents, including major Western countries (except for the US, Japan and Canada), and most countries in Asia and Europe, regardless of pressure from the US. China possesses three advantages when proposing this initiative. Firstly, it has advantages in the construction material industry and capacity in infrastructure construction. Secondly, China now has an annual savings of around 50 percent of GDP and foreign exchange reserve of 3.7 trillion dollars. So China has ample funds for financing investment in infrastructure construction for participating countries in the OBOR. Infrastructure is generally a bottleneck for development in developing countries, so the investment will be well received. Thirdly, China has an advantage in the developmental stage. Since reform and opening-up, China has become the world s factory and the largest exporter through the development of labor-intensive processing industries. With constantly rising wages in China these industries have gradually lost their comparative advantages and have to be relocated to other countries with a comparatively low wage level. Most countries along the OBOR have a GDP per capita of less than half of China s and thus are ideal destinations for the relocation of China s labor-intensive industries. Infrastructure construction of the OBOR will facilitate these countries to capture the window of opportunity of developing labor-intensive industries, create more jobs and increase exports. Experience since World War II shows that a developing country that is capable of seizing the window of opportunity arising from the international relocation of labor-intensive industries will be able to achieve twenty to thirty years of rapid development, enabling it to shake off poverty and move into the ranks of middle income and even high income countries. Such rapid development will in turn bring an increasingly expanding market long-coveted by developed countries. In the 1960s, when Japan started to transfer its labor-intensive industries overseas, her manufacturing industry employed 9.7 million people; in the 1980s, when the Four Asian Tigers went through the same stage, the manufacturing industry employed 2.3 million people in South Korea, 1.5 million people in Taiwan, less than 1 million people in Hong Kong and 0.5 million people in Singapore. By contrast, the figure for China, according to the third industrial

6 590 Justin Yifu Lin census, is 125 million with 85 million in labor-intensive industries, which means ample opportunities for all the developing countries along the OBOR to achieve industrialization and modernization simultaneously. That is the main reason why the response to China s OBOR initiative has been so positive. On the one hand, the initiative goes in line with China s own interests and will create an internationally peaceful development environment so that China can make better use of the domestic and international markets and resources; on the other hand, it will bring unprecedented development opportunities for other developing countries along the route and promote their industrialization and modernization. Overall, the FTZ pilot and the OBOR initiative are both new reform and opening-up strategies proposed in line with the changed domestic and international circumstances. Implementation of these reform and initiative can provide China with a sounder market economic system and a better external environment. It can not only help realize the great renaissance of the Chinese nation, but also facilitate the industrialization and modernization of other developing countries. The OBOR initiative, if well implemented, will contribute to a new order and pattern of international peace and development and be a win-win for all parties involved.

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