CHINA: SECOND THOUGHTS ON SHENZHEN

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T01058R000201780001-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 9
• Document Creation Date: December 22, 2016
• Document Release Date: October 8, 2009
• Sequence Number: 1
• Publication Date: July 31, 1985
• Content Type: REPORT

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i i /y~
Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
31 July 1985
China: Second Thoughts on Shenzhen
Summary
In a significant about-face, reform leaders have moderated their
support for the Shenzhen Special Economic Zone, once touted as the
model for economic reform and the 'opening to the outside.'
Shenzhen's poor
export performance, its disappointing results in attracting high tech foreign
firms, and continuing problems with corruption have drawn increasing fire
from conservative critics, forcing Deng to concede that the zone has not
been a success. Signs of Shenzhen's diminished stature include a freeze
on state funding to the zone and postponement of measures that would
have increased Shenzhen's autonomy. Beijing has also cut back on plans
to develop Shenzhen-like zones in 14 coasta'I cities.
We believe the downgrading of Shenzhen signals an adjustment of
China's development strategy. Although foreign trade and investment will
still be encouraged, the 'Shenzhen model' of granting foreign trade
autonomy to selected localities will probably be curtailed in favor of
renewed central control. China will probably place greater emphasis on
This memorandum was prepared by Office of East Asian Analysis.
Information available as of 31 July 1985 was used in its preparation. Comments and
queries are welcome and may be directed to the Chief, Domestic Issues, China Division,
OEA,
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the invigoration of established industrial bases, such as Shanghai, instead
of building zones from scratch. New foreign investment will be scrutinized
in terms of supplying needed technologies and contributing to China's
export potential. Efforts may be made to curtail the booming trade in
consumer goods from Hong Kong through Shenzhen, which some Chinese
leaders view as counterproductive and uncontrollable. The new trade
strategy will continue to provide opportunities for US and other Western
businesses, along with Soviet Bloc countries, to participate in China's
modernization. Shenzhen's fall from grace may bolster the reputations of
conservative critics of reform and harm the careers of several
Shenzhen and the Opening to the Outside
By far the largest and most developed of the four Special Economic Zones (SEZ),1
Shenzhen was once called the 'key to the future' by China's reform leaders. Established
in late 1980, Shenzhen was to offer foreigners an improved investment climate through
the use of tariff concessions, tax breaks, relatively cheap labor, and simplified
administrative procedures for setting up joint ventures. After an initial period of
infrastructure development, Shenzhen was expected to attract western high-tech firms
with the latest in production facilities for the Chinese to study, and the zone's
production was to be keyed to the export market to generate foreign exchange.
Since its establishment, Shenzhen has been the model for a key element of Deng
Xiaoping's policy of 'opening to the outside' -- encouraging local initiative in foreign
trade by granting limited trade autonomy to selected areas. Deng has told both national
and regional leaders to learn from Shenzhen, and a stream of officials has visited the
zone to study its methods of attracting and employing foreign technology and
investment. Against the advice of conservative leaders, in early 1984 Deng pushed for
establishment of 14 open coastal cities2 which were to follow Shenzhen's example.
An added- incentive for the development of the SEZs was the desire to showcase
China's ability and willingness to tolerate different economic systems as part of efforts
to "reunite" with Hong Kong, Macao, and Taiwan. Shenzhen, Zhuhai, and Xiamen officials
have been encouraged to build business ties with investors in Hong Kong, Macao, and
Taiwan, respectively.
1 Shenzhen, Zhuhai, and Shantou SEZs are located in? Guangdong Province. Xiamen SEZ
is located in Fujian Province.
2 Shanghai, Guangzhou, Tianjin, Dalian, Zhanjiang, Nantou, Ningbo, Wenzhou,
Qinhuangdao, Fuzhou, Lianyungang, Yantai, Beihai, and Qingdao were declared the "14
open coastal cities" in April 1984. Yinkou was added to the, list in April 1985, but PRC
reports have continued to refer to "14 open coastal` cities."
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Second Thoughts on Shenzhen
We believe two key issues led reform leaders to reevaluate their support for
Shenzhen early this year: the campaign to control official corruption, and the sharp,
unexpected drop in China's foreign exchange reserves. As the leadership focused on
these issues, Shenzhen's disappointing economic record and reputation as a center of
corrupt activities made the zone a target of high-level criticism.
Deng Xiaoping's comment in late June to an Algerian delegation that Shenzhen
was an 'experiment' which he hoped would, succeed, but which might fail, was the first
public indication that reform- leaders had tempered their support for the zone. Although
Shenzhen leaders have since claimed that Deng's comment does not represent any
change in his position, evidence suggests that Deng had earlier moderated his position
on the SEZs in the face of high-level criticism of the 'opening to the outside.'
We believe that Deng's
comment to the Algerians signaled his intention to stop expending political capital to
defend Shenzhen against its critics. State Councillor Gu Mu -- who heads the State
Council office in charge of the SEZs -- stated on 15 July that plans to develop the 14
open coastal cities have been scaled back to focus on the four most developed of the
cities (Shanghai, Tianjin, Dalian, and Guangzhou). We view this as evidence of a further
reorientation in China's trade policy.
Shenzhen's Disappointing Record
Nearly five years after its establishment, Shenzhen has yet to fulfill the
expectations of its supporters by becoming an economically viable generator of foreign
exchange earnings. Specifically:
o An unexpectedly large portion of Shenzhen investment has come from inland
Chinese sources as provinces and government ministries have sought to get a
share of Shenzhen's expertise, foreign exchange, and goods.
by the end of 1982
foreign investment accounted for about 60 percent of total capital construction
investment in the zone. Earlier this year, Premier Zhao Ziyang reportedly
indicated that foreign investment is now only 40 percent of the total.
o The type of foreign investment in Shenzhen has drawn leadership criticism.
Between late 1979 and mid-1983, only about 1'2 percent of investment was in
industrial projects; the remainder was almost entirely devoted to real estate
development and tourism facilities. The industrial projects which have been
established are primarily low technology -- out of 585 industrial projects funded
in the first half of 1983, 517 were in textiles and food processing, and only 16
were electronics firms. Shenzhen officials have had to offer concessionary terms
to attract the few showcase high-tech firms which do exist in the zone. Roughly
90 percent of foreign investment in Shenzhen has come from Hong Kong sources,
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primarily a spinoff from the real estate boom in the colony in the early 1980s.
Few US, Japanese, or West European firms have participated in the zone's
development.
o Shenzhen has not lived up to expectations of ..,producing primarily for export.
During a March interview with Hong Kong reporters, Vice Premier Yao Yilin stated
that only one-third of SEZ production is actually exported. A Hong Kong press
article quoted Gu Mu as stating that since mid-1984 Shenzhen's foreign exchange
earnings have been dropping. Other leadership statements imply that the zone
has become a net drain on China's foreign exchange reserves. Shenzhen's poor
export performance has become a source of acute embarrassment in light of
Beijing's discovery early this year of an unexpectedly large drop in foreign
exchange reserves.
Corruption in Shenzhen
Shenzhen`s disappointing economic results have left its backers with little
defense against charges that the zone is a center of'.corruption. Since late 1984,
mounting official corruption in China -- the so-called 'unhealthy practices' -- has
become a central political issue. The extent of corruption belies reformist claims that
they can control the corrosive aspects of Western society while promoting trade with
the West. Although Shenzhen has not been singled out for public rebuke -- perhaps
because such charges would embarrass Deng Xiaoping -~
Forms of corruption evident in Shenzhen include black-market currency
speculation, unauthorized export of agricultural products to Hong Kong, the widespread
practice of officials soliciting bribes to handle nearly all transactions, and smuggling of
consumer goods and what the government terms pornographic videotapes and literature
into China. Perpetrators include individual entrepreneurs, party cadre, government
departments, and provincial trade representatives. Efforts by Shenzhen officials to
attract tourists from Hong Kong reportedly have led them to establish casinos, massage
parlors, and brothels, all of which contribute to the image of the zone as being rife with
decadence and corruption.
As a result of Shenzhen's demotion from 'model' status, the zone will probably be
exposed to keener competition from other SEZs, the remaining open cities, and other
regions in China for new investments and development credits. The end result may be
to force Shenzhen officials to deal more aggressively, with problems in the zone, to work
harder to acquire high-technology industries, and to push exports.
According to Hong Kong press reporting, central financial support of the zone is
being frozen and may be cut back. Yao Yilin reportedly told Shenzhen officials in late
April that the "blood transfusions" of central funds to keep the zone alive couldn't
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continue. During a late June State Council conference on special zones and open cities,
Shenzhen was ordered to keep 1985 capital construction investments at last year's level
of 1.6 billion yuan, instead of the planned 2.5 billion Yuan. Budgets of the other three
SEZs were also frozen or cut back.
Several reforms that would have granted Shenzhen greater trade autonomy have
been delayed repeatedly, and may now be postponed indefinitely. They include the
activation of strengthened border facilities -- including a fence and numerous guard
posts --between Shenzhen and Guangdong Province and the issuing of a special
currency for the zone.
The "Opening to the Outside" Without Shenzhen
We believe China's policy of 'opening to the outside' will continue, both in
propaganda and in fact. China's need for foreign technology and investment is widely
recognized, and Chinese leaders understand that the country cannot afford to be seen
as a fickle business partner. The SEZs themselves won't be simply abandoned; China
will attempt to realize some return on its investment in the zones, and the Xiamen SEZ
will probably continue to receive preferential treatment as part of Beijing's efforts to
build commercial links with Taiwan.
China's development strategy with regard to foreign technology and investment
is likely to shift, however. Chinese leaders now admit that Shanghai and other
established industrial areas have been a better long-term economic success than
Shenzhen and can probably make better use of new ,development funds, whether from
domestic or overseas sources. As an example of this kind of thinking, a recent
economic article by a Peoples' Bank of China official', called for ending the emphasis on
attracting foreign investment to the southern special economic zones and replacing it
with a "northern strategy" which would bring more investment to China's interior and
permit greater access to China's domestic market by foreigners. While supporting, and
indeed expanding the open door policy, the article criticized the SEZs for leading to
unbalanced and narrowly focused foreign investment.
One of the lessons Chinese leaders may draw from Shenzhen is that the
decentralization of foreign trade authority leads to unacceptable confusion. The
unexpected drop in foreign currency reserves is regarded as one symptom of the lack of
central oversight over trade arrangements. Chinese leaders have also complained about
unnecessary duplication in imports, competition between imported products and
domestically produced goods, and encroachment of undesirable elements of foreign
culture, all of which have accompanied open trade between Shenzhen and Hong Kong.
Beijing moved to recentralize control over foreign trade this spring, setting restrictions
on localities' use of foreign exchange and banning local imports of motor vehicles,
videorecorders, and other consumer goods.
In our view, a shift to an 'opening to the outside' strategy which stresses
developing China's established bases and inland resources will provide continued
opportunities for US and other Western businessmen. Priority projects will include
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revitalization of the transportation network, energy development, natural resource
exploitation, and export promotion. Firms doing business in China probably will find
renewed involvement of central authorities in project approval and stiff bargaining over
financing arrangements.
The new trade strategy may also increase access for the Soviet Union and other
Eastern Btoc countries to Chinese trade opportunities. Soviet officials have complained
of being frozen out of the SEZs and the 14 open coastal cities, and they probably will
welcome a downgrading of the zones. It is widely believed that renovation of existing
plants, many of which were originally established by the Soviets in the 1950s, is an area
in which Soviet assistance is needed. Under the Economic Cooperation Agreement
signed in Moscow on 10 July, the Soviets will help China upgrade 17 plants arid may
transfer additional technology and capital goods. Chinese leaders may well regard
trading with Soviet government bureaus less threatening and troublesome than dealing
with the corrupting influence of Western businesses.
The Political Consequences of Shenzhen's Reevaluation
The SEZs' clear identification with Deng Xiaoping and his reformist proteges
suggest that a reevaluation of Shenzhen could be seen as a setback for the reform
program. Deng has visited Shenzhen several times and has encouraged other Chinese
leaders to do so in order to get a glimpse of the future China which reformers
envisioned. Deng's withdrawal of public support for Shenzhen has cost the SEZs their
most ardent and powerful supporter. Although Shenzhen's problems clearly have caused
Deng some political embarrassment, we do not believe that Deng's own leadership will
be significantly affected by Shenzhen's decline in stature.
Further political fallout from the downgrading. of Shenzhen is not yet evident, but
conservatives will almost certainly attempt to gain some political capital from Deng's
admission that the SEZs have been a mistake. Among second-echelon leaders, Premier
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Zhao Ziyang has been closely associated with the development of the zones, and he
may have continued to encourage deals in the zones which used foreign exchange until
signs of the drop in reserves became evident. Zhao was reportedly criticized for
economic problems during the National People's Congress session in April, and problems .
in Shenzhen may have been part of the charges leveled against him. State Councillor
Gu Mu is also a prime candidate for criticism over Shenzhen's record. It is possible he
wilt be among those scheduled to "retire" from the Party Secretariat at the party
delegates conference in September.
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Distribution:
National Security Council
1 -David Laux, Senior Asst for China, Taiwan, & Hong Kong, Room 302, OEOB
Department of State
1 -James Lilley, Principal Deputy Assistant Secretary (EAP), Room 6205
1 -Donald Anderson, Director, Office of Chinese Affairs (EAP/C), Room 4318
1 -Howard Lange, Deputy Director of Economic Affairs, Office of Chinese
Affairs (EAP/C), Room 4318
1 -Richard Howarth, Director, Office of Economic Policy (EAP/EP), Room 5321
1 -John Danylyk, Chief, INR/EC Communist Economic Relations Division,
Room 8662
1 -Donald Keyser,(EAP/CH), Room 4318
1 -Charles Martin, INR/EAP/CH, Room 8840
1 -Brian Evans, INR/EAP/CH, Room 8840
1 -Chris Clarke, INR/EAP/CH, Room 8840
Department of Defense
1 -James Kelly, Deputy Assistant Secretary, EAP, International Security
Affairs
Department of Treasury
1 -James Griffin, Office of East-West Economic Policy, Room 4450
Department of Commerce
1 -Christine Lucyk, Director, People's Republic of China Office, East
Asia and Pacific, Room 2317
1 -Office of Intelligence Liaison, Room 6854
Other
National Security Agency, Ft. Meade
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Central Intelligence Agency
1 - DO/EAR (5D38)
1 - DDI (7E47)
1 -Executive Director (7E12)
1 - NIC/Analytic Group
1 - NIO/EA (7E47)
1 - NIO/Econ (7E47)
1 - D/OEA (4F18)
2 - C/OEA/CH (4G32)
1 - OEA Research Director (4G48)
1 - C/OEA/SDS (4G32)
1 - C/OEA/CH/DEF (4G32)
1 - C/OEA/CH/DEV (4G32)
1 - C/OEA/CH/DOM (4G32)
1 - C/OEA/CH/FOR (4G32)
1 - C/OEA/NA (4G43)
1 - C/OEA/SA (4F38)
1 - PDB Staff (7G 15)
5 -CPAS/IMC/CB (7G15)
1 -CPAS/ILS (7G 15)
1 - CH/EA/RR (5D10)
1 - C/PES (7G 15)
1 -OCR/ISG (1H19)
1 - C/DO/PPS (3D01)
1 - D/OLL (7824)
1 - DOM Chrono
1 - FBIS/NEAAD/China Branch
31 July 1985
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