Here's Why The New Shanghai Free Trade Zone Is 'A Big Deal'

China is about to open up an area known as the Shanghai Free Trade Zone.

As Mamta Badkar explained earlier in the month, the zone is a 29-square KM area that will allow for more liberalized financial transactions and easier foreign direct investment.

In a note, SocGen's Wei Yao explains why this is a 'big deal'. Essentially you have to look at history. China experiments with test-case liberalizations before it undertakes much more radical liberalizations.

In order to understand the significance of this upcoming FTZ project, one needs to look at the history of China's reform and opening-up since 1978. Deng Xiaoping introduced market mechanisms into a highly closed, tightly controlled and near-dead economy via several flagship regional experiments. In particular, the establishment of the Shenzhen Special Economic Zone (SEZ) in 1980 re-opened the door to foreign direct investment. This SEZ model was adopted by a number of coastal cities from the mid-1980s. However, reform momentum stalled due to the political struggles of the late 1980s. Aiming to rekindle investor confidence, Deng made his famous southern tour in 1992, reaffirming the Chinese government's commitment to reform. One of the grand gestures following the tour was to grant Shanghai's Pudong area a big package of pro-business policy, opening up to overseas investment to a greater extent.

The overarching theme of all the reform in the 1980s and 1990s was, simply put, liberalisation. Local experiments in strategically important cities not only served as policy signals of reform commitment but provided guidance as to the path of upcoming changes.

Fast-forwarding to now, the new leadership is forcefully pushing for another big package of corporate sector reform in Shanghai at a time when the Chinese economy is clearly at a critical juncture. It is hard not to see the historical resemblance and infer the significance of this move.