How Special Economic Zones Led To China’s Success

By Thibault Serlet

Modern Shanghai is undoubtedly one of the world’s greatest cities. All of its landmarks reflect  Chinese cultural appreciation for efficiency and empiricism. The city’s skyline stretches far beyond the eye, further than that of any American city. There is no outward indication that the region was, only two generations ago, one of the world’s poorest.

China’s Special Economic Zones (SEZs) can be thanked for the nation’s remarkable transformation.

On the day Mao died in 1976, China was on the brink. Chairman Mao had replaced the anarchy of warlords with the brutality of authoritarian communism. His purges and cultural revolution were the least of China’s troubles. It was his “great leap forward” which killed the most people. Poor incentives and weak property rights resulted in a famine which killed 45 million people. Observers reported seeing peasants so famished they would eat the bark off trees.

At the time, not all of China was in crisis. Hong Kong had turned into a booming bastion of free market capitalism. Under the guidance of Sir Murray MacLehose, Hong Kong went from an obscure trading port to a global financial city. The city had opened itself to outside investment and trade while adopting sound free market policies. This allowed its exports to rapidly grow.

February 27,1972, Shanghai, China --- President Nixon holds his chopsticks in the ready position as Premier Chou En-lai (left) and Shanghai Communist Party leader Chang Chun-chiao reach in front of him for some tidbits at the beginning of the farewell banquet here. --- Image by © Bettmann/CORBISFebruary 27,1972, Shanghai, China — President Nixon holds his chopsticks in the ready position as Premier Chou En-lai (left) and Shanghai Communist Party leader Chang Chun-chiao reach in front of him for some tidbits at the beginning of the farewell banquet here. — Image by © Bettmann/CORBIS

The contrast between Hong Kong and mainland China was stark. Mainland officials realized that if China was to survive, it would need to look like Hong Kong. Only two years after Mao’s, China began negotiating trade deals with the United States. This began a wave of reforms, known as the “open door” policy.

After Mao’s failed attempts at wide-sweeping reform, the Chinese government was weary of change. Instead of liberalizing all of China’s economy at once, they decided to take the more cautious route of testing policies at the local level.

To do this, they increased political decentralization. For the first time in years, local officials could experiment with different models of economics. Officials could test the privatization of certain state-run industries without affecting the country as a whole.

Although local officials could now make certain decisions, these reforms didn’t go far enough for the Chinese government. Foreign investors complained that there were still too many intrusive barriers to business. In 1980, the National People’s Congress designated four cities as Special Economic Zones (SEZs). The creation of the SEZs was immediately followed by rapid private sector growth.

China’s high tax rates were also prohibitively expensive for Western investors. Officials completely abolished all tariffs in the development zones as long as the goods were for re-exportation. Corporate tax rates were also significantly reduced.

Prior to the creation of SEZs, private businesses were not allowed to hire workers. All labor had to be collectivized into public firms. In the SEZs, foreign firms could freely hire and fire local labor.

At the time, the Chinese government didn’t recognize property rights. During Mao’s cultural revolution, most of the land was nationalized. In the development zones, foreign companies could lease or buy land.

China’s economic reforms proved to be an immediate success. Within four years, the government decided to create 14 additional SEZs in the country’s major coastal cities. Now, it is estimated that there are over 1300 SEZs across China.

A map of China's SEZs by Hofstra University.
A map of China’s SEZs by Hofstra University.

With every wave of success, the government designated more areas as SEZs. Over time, these zones have become free-market enclaves which now dominate the China’s economy.

Modern SEZs are guided by four core principles: investment relies primarily on foreign capital, economic ventures will be run by Sino-foreign joint ventures, production is export-oriented, and prices will be primarily driven by market forces.

Many Chinese economists believe that the SEZs have played a key role in liberalizing the Chinese economy.

Western commentators often praise China’s move towards economic liberalism. They rarely talk about how this was accomplished. China tested different things in different places. Officials saw that where they tested communism, the result was starvation. They also saw that where they tested free markets, the result was prosperity. This is because testing, different policies in different places, helps quickly identify the sources of social problems.
Chinas SEZs

In the West, we have much to learn from China. Now, our own institutions are in dire need of reform. The problem is that we have an unprecedented level of gridlock and political polarization. It is time for us to learn from the East, and create special economic zones of our own. That way, everyone’s policies will have a fair chance at getting tested.

It is hard to imagine a starving China when looking at Shanghai’s futuristic skyline. What China had to overcome makes modern Western problems seem trivial by comparison. If, through decentralization, China can turn itself around, then what can the West accomplish with the same policies?

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