China touts Hainan, its duty-free island, as having a $1 trillion trade surplus

As tariffs rise around the world and President Trump promises an end to decades of globalization, China’s leadership is trumpeting a tropical island as evidence that it is moving in the opposite direction.

The island of Hainan – a province of China off the country’s southern coast that is 50 times the size of Singapore – last month eliminated tariffs on most imports, cut corporate and personal taxes and declared itself the world’s largest “free trade port.” China declared it a symbol of its willingness to engage in two-way trade with the world.

Xi Jinping, China’s supreme leader, called Hainan “an important gateway for China’s opening into the new era.”

As portrayed by Beijing, Hainan’s experiment with duty-free trade recalls the spirit of China’s early reform era after the death of Mao Zedong in 1976. The Communist Party abandoned socialist dogma and began testing bold free-market policies in certain areas. The ones that worked were rolled out more widely.

China’s place in global trade is now very different. The country has developed into an unrivaled manufacturing power and the second largest economy in the world. Mr. Xi has repeatedly called for self-reliance and has worked to ensure that China is never dependent on anything foreign. He has shown little interest in changing the high tariffs and export-focused policies that helped China run a gigantic $1 trillion trade surplus last year.

“There is no sign that Hainan is a pioneer of a broader and more systematic opening of the national economy,” said Richard McGregor, senior fellow for East Asia at the Lowy Institute, an Australian research center. “At a time of record-breaking trade surpluses,” he added, “Hainan’s new role as a free trader has a strong whiff of bait-and-switch in political and public relations terms.”

Most foreign goods can now flow freely to Hainan, where 10 million people make up less than one percent of China’s total population. However, these imports are not allowed to leave the island for other parts of the country unless they meet strict conditions.

The combination of these measures is intended to prevent Hainan’s duty-free imports from leaking into other parts of the country where high tariffs continue to apply.

The fact that China has no plans to give up its protectionist trade policy became clear a few days after the Hainan free trade port went into operation on December 18th: the Ministry of Commerce in Beijing imposed tariffs of up to 42.7 percent on milk imports from Europe to China.

On the last day of the year, the ministry announced so-called “Imported Beef Safeguards,” a system of quotas and 55 percent tariffs intended to limit imports. And on Tuesday, the country announced it would impose strict controls on the export of goods to Japan that serve both civilian and military purposes.

Goods imported into Hainan cannot be shipped duty-free to other parts of China unless they have been processed in a way that increases their value by at least 30 percent.

In the New Port of Haikou, a gigantic passenger and cargo terminal in the provincial capital, ships travel day and night to the neighboring province of Guangdong. But what was once a domestic transportation hub has effectively become an international border. Chinese customs control the flow of goods from Hainan to other parts of China and check trucks for duty-free goods smuggled to the rest of the country.

Although severely limited, the ability to access the Chinese market beyond Hainan is already attracting some foreign companies that would otherwise face high tariffs if they try to sell to Guangdong or other Chinese provinces.

Nesredin Hussein, a coffee trader from Ethiopia, recently rented a warehouse near Haikou to store beans imported to the island duty-free. He plans to purchase roasting equipment so he can process the coffee brought into Hainan duty-free and then ship it to other parts of China for sale without paying duties or taxes.

“For me, this is a very good opportunity,” he said, given China’s insatiable appetite for coffee, noting that he would otherwise have to pay up to 30 percent in tariffs and other taxes on any beans he imported directly into mainland China. “Here the rate is zero,” he said after a visit with his wife and three children to the Hainan branch of Harrow School, an elite British boarding school.

Less convinced is Kamthon Wangudom, an ethnic Chinese businessman from Thailand who was invited to Hainan in December to visit a village where his ancestors lived and was first led to an exhibition center where he presented the island’s investment opportunities. He said his renewable energy company in Bangkok has already invested in Taiwan, Japan and the Philippines but is staying away from China because it is “too big and too complicated.” He is skeptical that the new customs regime will change much.

Hainan likes to compare itself to Hawaii for its palm-lined beaches and resorts; Like Hawaii, it is also dotted with military installations. These include a huge naval base near the southern resort of Sanya, which grew rapidly as China asserted its claims in the South China Sea. Mr. Xi visited Hainan in November to publicize the duty-free policy. However, his main task was to inspect the naval base and attend the commissioning of a new aircraft carrier. Mr. Xi made clear that Hainan’s strategic importance means that security interests must take precedence over economic ambitions.

Communist Party officials have decorated Haikou with red banners praising Mr. Xi and a “new era of openness.” Still, they declined to be interviewed for this article and urged private companies on the island not to discuss how the new duty-free regime might help or hurt their business.

Officials have good reason to be nervous. Days before the duty-free system was introduced last month, a Shanghai court sentenced the island’s former longtime Communist Party leader Luo Baoming to 15 years in prison for accepting more than 113 million yuan (about $16 million) in bribes over his nearly three-decade career.

Mr. Luo was the latest high-ranking Hainanese official to be jailed for corruption in recent years.

Hainan has a history of big plans that often disappoint, starting with its designation as China’s last but largest special economic zone in 1988, a surge in cooperation with foreign companies that has declined rapidly since Mr. Xi took power in 2012.

Because Hainan couldn’t keep up with the extraordinary economic growth of competing special zones like Shenzhen next to Hong Kong, it was largely viewed as a sunny side country for years. It expanded its tourism industry, including medical tourism, and built new highways and high-speed rail lines. In the 1990s, the island experienced a real estate crash, the first in China under communism.

Mr. Xi first announced plans to turn Hainan into a free trade mecca in 2018. The project began with the opening of huge duty-free shopping centers in Haikou and Sanya. This attracted Chinese tourists looking for cheap foreign luxury brands, but failed to reverse the economic situation of an island still reeling from the effects of the housing crisis.

According to a study by the National University of Singapore’s Asia Competitiveness Institute, today’s development of the Hainan Free Port “faces a harsh reality check.” Hainan is far less successful than other Chinese special economic zones and attracts relatively little foreign direct investment, the report said.

For others, however, Hainan’s importance lies in its role as a testing ground for innovative policies that do not falter.

The free trade port experiment will allow China to try new approaches in areas such as finance, education and taxation, said Lauren Johnson, founder of New South Economics, a consulting firm in Melbourne, Australia, “while protecting the status quo on the mainland.”