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Financing Special Economic Zones in China

Economic Research Institute (+82-2-759-5480) 2007.01.26 1744

Financing Special Economic Zones in China

Author: Chan Man Hung, Thomas(China Business Centre, Hong Kong Polytechnic University, Hong Kong)

China’s Special Economic Zones have been regarded as the major driver for institutional reform of China since their establishment in the late 1970s. From the very beginning the Special Economic Zones have been used as an experiment for the gradual implementation of market policies that China borrowed or learned from overseas, including Hong Kong. The Chinese leadership has given no direct financial allocations for the experiment. Instead the new market institutions and policies that were introduced as exception to the existing centrally planned economic system have been expected to generate enough revenues or economic rents to support the development and transformation of the zones. Four zones were initially set up and with the success of Shenzhen Special Economic Zone, the policy and market institutions and measures evolved under it in the zones have been introduced to an ever expanding territory in China until the Chinese accession to the WTO in 2002, which enforces national treatment for all localities and entities in China, including the Special Economic Zones.
 This paper studies the mode of financing of the Special Economic zones using the most successful one, the Shenzhen Special Economic Zone, as an example. It is found that the first stage of development in Shenzhen from 1979 to 1992, the city had achieved very quickly fiscal balance on the basis of very fast economic growth.  The growth relied on heavy capital investment that built up local modern infrastructure, which in turn facilitated and attracted industrial relocation from Hong Kong and overseas and transformed the local economy into a dynamic industrial processing economy for exports. At the start, borrowings from Chinese banks, economic rents from diversion of materials from the price-suppressing centrally planned redistributive system to the emergent market distribution system in the Special Economic zone and from a lucrative import trade, as well as some investments from Hong Kong and other parts of China for real estate speculation and development in the zone had provided the seed money for financing the rapid expansion in local fixed asset investment.
 This was made possible by the exceptions to the existing policy regime of China by the market-oriented Special Economic Zone policy. The two interacted and reinforced each other forming a virtuous circle that maintains the investment-led high growth system on the basis of FDI-induced export oriented industrial processing. Local economic and industrial dynamism had become firmly installed by the mid-1990s and the gradual loss of policy advantages in subsequent years when China becomes more and more liberalized economically of the Special Economic Zones has not caused any dislocation in the growth trajectory of Shenzhen.
 By the early 21st Century Shenzhen has emerged as one of the leading city economies of China, competing with Shanghai and Beijing. Although not all Special Economic Zones of China have been as successful as Shenzhen, the example of Shenzhen and especially its mode of financing should have good implications for North Korea in its current economic reform.