China’s massive Hainan bet

Beijing is relying on an unlikely destination, a lush tropical island, to launch what some hope will be a second round of reforms and open up the Chinese economy. But the jury is still out on whether the bet will pay off in the Xi Jinping era. Ananth Krishnan reports on the ambitious plan and the challenges in implementing it  

March 11, 2023 03:15 am | Updated 09:38 am IST

Shipping containers at Haikou Port in China’s southern Hainan province.

Shipping containers at Haikou Port in China’s southern Hainan province. | Photo Credit: AFP

On March 10, 2023, Xi Jinping officially began his precedent-defying third term, with the ceremonial National People’s Congress (NPC) confirming him as China’s President for the next five years. The first decade of the Xi era, which was defined by China’s return to one-man rule and the end of the collective leadership model, came to a close with three years of the ‘zero-COVID’ policy essentially walling China off from the rest of the world.

A decade into what Beijing has declared as “a new era” under Xi, China stands at a crossroads. Beijing is facing searching questions about its place in the world, and many observers, both within China and abroad, are asking if the reform era, which saw China opening up and integrating with the world, has ended. Three years of isolation only reinforced those perceptions.

A grand plan for Hainan

Forty years ago, China stood at a similar crossroads. In 1992, Deng Xiaoping embarked on a “southern tour” to give his stalled reforms a second wind from Shenzhen, just three years after the events at Tiananmen had shaken China and the world. Xi appeared to be taking a leaf out of the Deng play book when, right after last year’s NPC session, he decided to begin the last year of his second term with his own southern tour.

File photo of Chinese president Xi Jinping delivering a speech via video link in Hainan Province.

File photo of Chinese president Xi Jinping delivering a speech via video link in Hainan Province. | Photo Credit: AP

Xi headed even further south, to the island province of Hainan, where he called for accelerating plans to build what is being billed as China’s first “Free Trade Port” (FTP). That trip ended up going largely unnoticed given the messy end to Xi’s second term that came in the following months. There were numerous, harsh zero-COVID lockdowns, including in Hainan; unprecedented protests in November; and finally, the sudden, almost overnight, withdrawal of the policy the following month.

A picture of Haikou in China’s southern Hainan province.

A picture of Haikou in China’s southern Hainan province. | Photo Credit: AFP

Now that the zero-COVID walls have come down and Xi has secured his third term, Beijing’s focus is turning to kick-starting its beleaguered economy that is grappling with not only the after-effects of COVID policies, but other long-persisting problems, such as rising local government debt and an ailing property sector. Complicating its efforts are worsening relations with the West and the U.S. in particular, and trade and technology tensions that threaten to derail Beijing’s quest to become the world’s largest economy and a leading global innovation power.

Xi’s plans for Hainan offer a clue into China’s broader strategy to deal with these headwinds and to deepen its position as an economic lynchpin for the region. The FTP blueprint is certainly ambitious. Last year, Xi called for accelerating the first phase of the plan, which aims to establish the 35,000 sq km island as China’s most open economic region by 2025. The ultimate goal is to build a tropical Dubai in the middle of the South China Sea by 2035. The stakes for Beijing and the region are enormous. “After Shenzhen and Shanghai,” says Wang Daxue, an official with the Hainan government, “this will be the third most important event in China’s reform and opening up history.” The jury, however, is out on whether Hainan will be a transformative success story like Shenzhen or underwhelm, like Shanghai’s much-celebrated free trade zone launched a decade ago.

Residental buildings in Sanya, in China’s southern Hainan province.

Residental buildings in Sanya, in China’s southern Hainan province. | Photo Credit: AFP

Experiments under way

Hainan, a lush tropical island that is closer to Hanoi than Beijing, is an unlikely location for a potential global trading hub. It is located just off the Chinese mainland in the crystal-clear waters of the South China Sea. Tourism drives its economy, with millions of mainland tourists descending on the island every year to enjoy its tropical weather and beaches. Home to 10 million people, the island was carved out of Guangdong province and given its own administrative status in 1988. Since then, it has been used as a testing ground for economic reform policies. Property reforms in the early 1990s were rolled out in Hainan and later across China, heralding a real estate boom. This ended up driving Chinese economic growth for three decades.

The FTP plan, by 2035, will essentially establish Hainan as a separate administrative trading entity within China. At its heart is what’s being called the “free flow through the first line, control at the second line” model. Goods can enter the “first line” from overseas to Hainan freely, with the usual customs scrutiny kicking in only at the “second line” if they subsequently enter the Chinese mainland. This is a first-of-its-kind trading arrangement for China. The plan proposes “five frees” — another first for China — referring to free trade, investment, cross-border capital flows, transportation, and exit and entry. How “free,” particularly on the fifth point, remains uncertain, given China’s generally tight immigration controls.

The broader idea is to attract foreign enterprises — particularly from Southeast Asia, given its proximity — to use Hainan as a base for trade, offering incentives such as zero tariffs and the lowest tax rate in China.

Haikou, the sprawling and modern capital in the northern edge of the island, and Sanya, a tourist paradise and a naval base in the far south, are the twin economic engines for the plan. The infrastructure is already in place. A bullet train link constructed in 2010 runs all along the island’s eastern coast, covering the 300 km distance between the two cities in a little over 90 minutes.

Since the announcement of the FTP in 2018, the plan’s progress has been measured steady, if unspectacular. Three years of zero-COVID have hardly been the best advertisement for openness. The province’s $64 billion GDP ranks it fourth from bottom of China’s 31 provinces, only higher than the western provinces of Ningxia, Qinghai and Tibet. In 2021, foreign investment stood at $3.5 billion. The number of foreign-funded companies had, however, close to doubled, to a little under 2,000.

On Sanya’s northeastern suburbs is a cluster of high-rise buildings. The “tax-free city” is still a work in progress — massive construction cranes dot the landscape — but there were long lines on a recent afternoon outside luxury goods stores. For years, Chinese consumers have travelled abroad to lap up luxury goods, from Louis Vuitton handbags to Tiffany jewellery. The idea now, explains Zhao Jing, a director at the Tax-Free City, is to redirect them within China. The rules of the city allow Chinese citizens to purchase goods duty-free, as long as they have a flight ticket out of Sanya to anywhere in the mainland. Once purchased, the goods will be kept for pick up at Sanya airport. The elaborate arrangements are to prevent black market sales.

People wait in line to enter an Alexander McQueen store at a shopping complex in Sanya, Hainan province, China.

People wait in line to enter an Alexander McQueen store at a shopping complex in Sanya, Hainan province, China. | Photo Credit: REUTERS

Duty-free goods and free trade aren’t the only experiments under way in Hainan; the island is also serving as a testing ground for China’s new energy transport policies. By 2030, Hainan will completely ban the sale of fuel cars. The surge in electric vehicles (EV) on the streets of Haikou — easily noticed by their green licence plates — is among the fastest in China, because of a tax exemption policy. The number of electric cars in the province has risen from 20,577 units in 2018 to a massive 1,91,937 in 2022, up from 1.62% to now 10.46% of all vehicles. This is the highest proportion anywhere in China. Also noticeable is that a majority of the cars are domestic brands. The only overseas EV manufacturer in the top five, as of sales in 2021, was Tesla. It ranked fifth, accounting for 5% of the market, trailing behind Chinese car-maker BYD, which has a 14.4% share.

The Sanya shopping complex.

The Sanya shopping complex. | Photo Credit: REUTERS

Experimentation has been critical to the success of economic reforms in China, going back to the 1980s. Policies have been first tested in select cities or regions. Those that worked were rolled out elsewhere, while those that failed were quietly discarded. This is why, Hainan’s officials explain, the FTP is being rolled out in stages to see what works before 2035. Beijing hopes that by then, Hainan will be giving Hong Kong some competition.

Hurdles to cross

There are, however, several hurdles that remain. One major reason why the reforms process, described by Deng as crossing the river while feeling the stones, worked previously was the political decentralisation pushed by Deng. Provinces were given space to work out their own policies. Perhaps the single biggest political legacy of the Xi era has been rolling back the autonomy of provinces. In recent interviews, officials in two local provinces said recent years had seen some policy paralysis in the bureaucracy because the fear of getting decisions wrong was overwhelming, so much so that doing nothing was a safer option. To what degree Hainan’s opening will be micromanaged by Beijing or left to local officials remains an open question.

Another major hurdle, as far as foreign investors will be concerned, is about the legal protections on offer. Hainan’s FTP plan promises international standards. Over the Jiang Zemin and Hu Jintao years, China enacted a range of judicial reforms to professionalise the courts and create conditions that would enable an inflow of foreign investment and enterprises, which worked remarkably well in attracting business despite China’s party-controlled legal system. However, the current perception among most foreign companies is that the past decade has seen a rolling back of already modest judicial autonomy and a reassertion of party control.

The other broader tension of the past decade has been between the desire to integrate China more closely with the world economically while exercising Chinese power more assertively. Some of the same countries that Beijing is looking to attract to Hainan are those that are contesting Beijing’s tightening military grip in the South China Sea.

Relations with India are another case in point. A burgeoning trade relationship continues, but the flood of Chinese investment into India, which both countries had, prior to 2020, seen as a positive force for economic integration, has reduced to a trickle following the People’s Liberation Army’s transgressions across the Line of Actual Control (LAC). While the LAC, and the stalemate in India-China relations, remain unresolved, Xi has begun his third term by appearing to course-correct, at least tactically, elsewhere, and woo the region amid Beijing’s primary strategic challenge — worsening relations with the U.S. China is positioning itself as the defender of globalisation and of developing countries, a message that a Belt and Road summit later this year is expected to reinforce.

Indeed, this is also the broader message of the Hainan project. “Hainan is a vivid example of China’s commitment to the future,” says Zhou Li, a Counsellor at the Foreign Ministry in Beijing. “It highlights China’s resolution of further opening. A free trade port represents the world’s highest level of opening up, and demonstrates that China’s door will not close, but open wider and wider.”

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