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For centuries, the utilization of free trade has lifted many countries into economic success, raising both the quality of life and money brought into each family, as well as the abundance of products available for consumption by the masses. Countries like the United States, which is less than 300 years old, have gone from zero to hero on the world stage by having a free market economy. Since the Post-Mao era, China’s economic climb and search for the same success that many other countries have claimed in the name of free-market capitalism. Chairman Deng first proposed the idea of certain cities and provinces being free market zones, know as special economic zones. These zones have extremely low taxes, low regulations, and surplus amounts of free trade. In 1997, Hong Kong officially became Chinese territory, and not soon after began its role as a special administrative region, an area where a separate governmental system could take place, while still being under the ultimate control of the People's Republic. Since then, Hong Kong has gone on to become one of the wealthiest metropolitan areas in the world, and, year after year, is ranked as the most economically free area in the world (World Economic Freedom Index). However, these successful specs of capitalism have an unintended consequence, they have created an economic divide of extreme intensity across province lines within China, specifically a scarcity of economic freedom in rural areas. However, the solution to this divide is not to eliminate the SEZ’s, but rather to liberate the country’s entire economic system, essentially making China a Special Economic Zone.

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Special economic zones in China: Do they work?

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Jim Coleman, head of economics at BuroHappold Engineering, and Stephen King, chief global economist at HSBC, discuss whether China's special economic zones are a benefit to the economy.

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The special treatment of special administrative regions within China has caused a class separation between the mainland and the SAR’s. Hong Kong. A city that many consider to be the poster child of free trade success. Known for its luxurious shopping and towering buildings, Hong Kong is the epitome of luxury. With a GDP per-capita that rivals cities like Singapore and countries like Japan, it’s no wonder why Hong Kong is one of the wealthiest cities in the world. However, despite being part of the People's Republic of  China, Hong Kong tells a very different story. Much of the laws are the same, yielding strict punishments for criminal actions like drug crimes and stealing. Yet, Hong Kong’s GDP per capita is nearly 6 times that of the rest of China (CEIC) at more than 43,000 USD. This disparity is due to the vastly different economic systems between the two, and more importantly, a scarcity of economic freedom in rural areas. The World Economic Freedom Index claims that In Hong Kong, the highest personal tax rate is 17%, while in mainland China the top personal tax rate is 45% (World Economic Index).  This imbalance has created a huge class separation. The rich and wealthy can afford to live in Hong Kong, with all the luxuries of the world, while the poor and impoverished people of mainland China suffer in what many do consider to be slums.
The unequal distribution of trading resources across China has created a huge economic divide within China. Beyond the disparity of wealth based on governance regions, the resources that contribute to much of China’s GDP and wealth are poorly spread out. CIEC statistics show that 7 of the Special Economic Zones within China, being Kashgar, Xiamen, Shantou, Zhuhai, Haining, Shenzhen, and Hainan, account for 60% of exports and 22% of national GDP,  yet makeup just 2.3% of China’s population (CIEC). This explains why the GDP per capita of Shenzhen is a staggering 25,000 USD, while the rural Hunan Province’s GDP per capita is just 6,976USD (CEIC). Regardless of the CCP’s initiative to redistribute any wealth, clearly those in Special Economic Zones benefit tremendously more than those who reside in more communities excluded by the unfair Special Economic Zones.

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China | Economic Indicators, Historic Data & Forecasts

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Discover economic indicators for China, such as GDP, GNP and FDI to use in your data forecasts and economic reports on the Chinese economy with CEIC.

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This problem has not yet been addressed simply because of the power that the elites in the special economic zones have. For instance, the world's largest company, Apple, produces their iPhones exclusively in Shenzhen. If China wanted to tax these companies in order to provide for the rural areas more than companies like Apple would just get up and leave. In the Special Administrative Regions, namely Hong Kong and Macau, the people are still very much so under foreign influence. Hong Kong was only relinquished by the British in 1991 (Textbook), so much of China could still be adapting to their presence and the CCP could still be figuring out what exactly to do with them. Furthermore, President Xi loves Hong Kong. In fact, President Xi recently pledged to make the city an “international innovation hub” (State Funds For Hong Kong) through the use of state funds. President Xi clearly does not realize the real problem created by Special Economic Zones and Special Administrative Regions, they create more division that is directly opposed to the original ideologies of the founders of the Chinese Communist Party.

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chinese national engineering research centres

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Will state funds for Hong Kong scientists spur innovation or stifle it?

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Researchers show palpable excitement about the new possibilities open to them, but others fear for academic freedom

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The current effects of this crisis are good for some and bad for others. On the side of the Special Economic Zones, their economic prosperity only continues to grow. Shenzhen has surpassed Singapore in terms of nominal GDP, and will only continue to grow. As the Special Economic Zones grow, they become more and more capitalistic, which is good, as that means general prosperity for the people of the region. However, as the SEZ’s grow, so does the economic divide within China. Economic divide in itself might not be so bad, as the United States has plenty of it. But what makes the Economic divide within China particularly troubling is which economic groups the divide benefits. The ones on top of the economic scene, the wealthy traders and business elites, are gaining more and more influence. However, the ones an on the bottom of the divide are the farmers, the ones who live in poor, rural communities. Naturally, the farmers will want to move out of this economic hierarchy and into a higher class, but this hierarchy is antithetical to what Mao Zedong originally had in mind for communist China. If the farmers do decide to start a new life in an urban supercenter, like the rapidly growing Shenzhen, then there would be no motivation to be a farmer, thus creating a massive food shortage even greater than the one that already exists.

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The CCP response to this crisis will be to increase the amount of special economic zones in China, eventually making the entire country a capitalist superpower. If China continues its pattern so far, more and more constituencies will become Special Economic Zones. As previously stated, President Xi is a huge supporter of the Special Economic Zones and Special Administrative Regions. His adherence to the growth of them is undeniable, as he has created a new Special Economic Zone and created many “business parks” where free trade can exist in large, restricted cities like Beijing. If this same trend continues, Xi will continue freeing and losing the economic restrictions across China. This could, however, be a solution, but only in the most extreme sense. This would require the total liberation of China’s economy towards a capitalist, or at the bare minimum, a mixed economy, and this would take time.  While this may seem like a considerable stretch, President Xi frequently makes measurable strides towards a more liberated economy (Wong). Despite Referencing “National Rejuvenation” (Secure a Decisive Victory) for China in his address to congress, words mean nothing when compared to Xi actions regarding economic policy. The earliest signs of Xi’s true retaliation against Mao and is economic ideals root from his childhood. As a young child, Xi suffered greatly during the cultural revolution, as his father faced persecution and Xi even enjoyed his fair share of time in a re-education camp (Wang). In words, Xi may honor Mao and say that he wants to rejuvenate China’s economy, but in truth, he is nothing like the first chairman.

Furthermore, over time, the special economic zones have shown Xi and his party that a mixed economy can function very well, but along with this, they have created a divide across province lines that the Chinese Communist Party chooses to ignore. One Author describes Shenzhen as “universally held up as one of capitalism’s great success stories” (Xi Urges Special Economic Zones) and credits most of its success to the ex-Chairman Deng and his crony, yet arguably successful capitalism. The most likely action to be taken by President Xi is the following of manu of the same policies that proved successful under Deng. However, like the rest of the party, present, and past, Xi fails to see the negative effects of a mixed economy.

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Xi urges special economic zones to serve as window on reform, opening-up - Chinadaily.com.cn

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President Xi Jinping on Friday urged special economic zones (SEZs) to continue as important experimental platforms for reform and opening-up.

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On the other hand, the CCP will realize that the country is leaning too far towards the capitalist ways and instead eliminate the SEZ’s entirely. The party has been, as previously stated, taken economic actions that are truly antithetical to the original communist beliefs of equality. For this reason, another logical course that the party might take would be to do a complete 180 and eliminate the special economic zones altogether. This action would coincide with Karl Marx’s communism, which stated that capitalism has created enough production to sustain a communist society, and creating more production is exactly what the special economic zones and the special administrative regions have done, they have enhanced production within China to a level that could sustain a fully communist state. Furthermore, Xi’s support of the looming US-China trade war that could impair the full utilization of Special Economic Zones (Aleem), may represent a dislike for the special zones. However, this solution is not as likely as the CCP continuing their trend of liberating China more and more. This action would be incredibly dull-witted for Xi to suddenly reverse all the work that he has put into the special zones and regions, and would also require him to neglect the success that the zones have contributed for their residents. Although these zones have greatly helped the populations in which they encompass, they have created an economically divided China across province lines. So in reality, Xi only does have two practical choices regarding the handling of special economic zones and special administrative regions: he can either turn the rest of the country into a capitalist powerhouse just like them, or turn the special zones into an economic eyesore like the rest of the country (CEIC). If Xi does truly care about the well being of China, he will take the areas that are currently on the poor side of the economic inequality created by the special economic zones and special administrative regions, namely rural regions like Hunan, as well as some tightly controlled megacities, like Beijing, and turn these zones into free market powerhouses.

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President Donald Trump is sending his top economic advisers to Beijing this week for talks to avert a possible trade war with China.

US Treasury Secretary Steve Mnuchin, US Trade Representative Robert Lighthizer, and other senior economic officials will meet with Chinese officials on Thursday and Friday to discuss the two countries' trade disagreements.

Among other things, the US wants China to import more American goods and to stop forcing American companies to hand over their prized intellectual property if they want to do business in China.

It already looks like talks are going to be tough. Chinese officials have declared they will refuse to discuss two of the US's biggest demands, and US officials are signaling that they aren't particularly optimistic.

"I'm always hoping but not always hopeful," Lighthizer said at a US Chamber of Commerce event on Tuesday in advance of the China trip. "It's a big, big challenge. There's a very different system over there and a system that, in all honesty, has worked very well for the Chinese."

If the two countries do manage to strike a deal, it could dramatically reduce tensions between the two world's largest economies. But if they don't strike a deal, or at least make serious progress toward one, things could go south fast - perhaps even escalating into a full-on trade war.

That sounds super scary. But what is a trade war, actually? What would it mean for the average American?

What follows is a brief guide to what a trade war is and why it could be so costly for both the US and China.

What is a trade war?

To understand what a trade war is, you first need to know what a normal trade dispute looks like.

Countries disagree with each other all the time about what counts as an unfair trade practice, clashing over policies like government subsidies for industries. There are a few different ways they handle their disagreements.

Let's say the US finds out that Country X uses generous government subsidies to make its production of tennis balls cheaper and give them an unfair price advantage over tennis balls made in the US. The US then has a few options for how to respond.

Washington can take Country X to the World Trade Organization - the world's supreme court on trade - and complain about its subsidies of tennis balls. The hope would be that the WTO forces Country X to cut its subsidies or gives the US permission to use trade barriers against Country X's tennis balls.

The second option the US has is to initiate direct negotiations with Country X over its tennis ball subsidies and come to some kind of compromise agreement.

If neither of those works or seems desirable, the US could impose tariffs, or punitive border taxes, on Country X's tennis balls and say it won't let up until the tennis ball subsidies are reversed. Country X might then choose to come to the negotiating table to try to find a solution. The problem is that it could also choose to impose its own tariffs on an American export that it thinks the US handles unfairly.

Experts say that what separates a trade dispute from a trade war is the way that third situation unfolds. It's a trade dispute if the US and Country X's tariffs on each other are one-off strikes. But if the initial tit-for-tat causes further escalations, in the form of higher or more tariffs, then it becomes a trade war.

Phil Levy, who was a senior official on President George W. Bush's Council of Economic Advisers, told me that his rule of thumb for characterizing something as a trade war is that the escalation of trade barriers is "uncontrolled."

That is, when disputes veer from the conventional channels for sorting out disputes - and threaten to become the source of serious economic harm for both economies.

Are the US and China heading toward a trade war?

The US and China are already engaging in what Monica de Bolle, a senior fellow at the generally pro-free trade Peterson Institute for International Economics, calls a "pre-trade war."

First, on April 3, Trump unveiled a list of more than 1,300 Chinese exports - which included flat-screen televisions, aircraft parts, and medical devices - that he said he plans to hit with 25 percent tariffs. The tariffs are intended to punish Beijing for restricting US investment in China and stealing American intellectual property. Combined, they would affect about $50 billion worth of Chinese exports.

The very next day, China struck back, unveiling its own list of US exports that it plans to hit with 25 percent tariffs. The proposed package could affect more than 100 American-made products, including cars, airplanes, and soybeans - the top US agricultural export to China. Combined, they would cover about $50 billion worth of US exports, perfectly mirroring the US tariffs.

But it didn't stop there. The day after China's announcement, Trump directed his trade team to identify tariffs on an additional $100 billion worth of goods, clearly intending to escalate even further after seeing Beijing's readiness to match his initial tariffs.

Levy says that's the moment it switched to a potential trade war. The Trump administration's original proposal for tariffs on $50 billion worth of Chinese exports was specifically designed to compensate the US economy for the amount of revenue it's lost due to Chinese intellectual property theft. But Trump's rationale for the additional $100 billion seems to be pure one-upmanship.

The next day, a spokesperson for China's Ministry of Commerce said that China will fight "at any cost" and take "comprehensive countermeasures" to Trump's latest measures.

Who would win a US-China trade war?

Trump has said he thinks trade wars are "easy to win" if the US exports less to a country than that country exports to the US. The logic is that the US has more targets to choose from to hit with tariffs or quotas (caps on the total amount of the country's exports) than the other country has.

The US's trade deficit of $375 billion with China - the amount by which its imports from China exceed its exports to China - is already pretty big, which means the US should have a lot more targets than China.

The US released a list of potential Chinese targets that covers more than 1,000 different items, but there's a focus on high-tech materials, including medical devices, machinery, aircraft parts, batteries, and flat-screen TVs. Tariffs on those products will make them more expensive and hurt the Chinese companies that manufacture them.

But experts say that Trump would be mistaken to think the US doesn't have a lot to lose.

One reason is that nearly every tariff Trump places on a Chinese export to the US doesn't just hurt China - it also hurts US producers and consumers. Trade with China saves typical American households up to $850 a year, and that extra money gets spread across the economy and helps keep people employed in a variety of domestic industries. That could change if higher prices lead more Americans to change their buying patterns.

US businesses could also feel the sting because Trump's tariffs on machinery and high-tech components from China would almost certainly mean US manufacturers of things like aircraft and cars have to spend more than they do now.

The Trump administration hasn't said what new Chinese products could be hit by the additional $100 billion in tariffs, but analysts say it's going to probably include a lot more essential consumer goods like cellphones, laptops, and furniture. Again, a double-edged sword - it'll deal a blow to the Chinese companies that make them and the US consumers that buy them.

China might not have as many exports to choose from, but the ones that it can hit are going to sting. Beijing is looking to hammer US agricultural exports produced in states that Trump and the GOP consider vital political strongholds. If China imposed its proposed tariffs, it would cause demand for those US exports to slump in China, and that in turn could dent profits and cause layoffs in those industries.

China's threat to put tariffs on soybeans is something the administration will take particularly seriously. China buys about a third of the US's soybean exports, making it far and away the largest importer in the world for the American crop. The biggest soybean producers in the US include Ohio, Iowa, Missouri, and Indiana - states in the heart of Trump country where neither the president nor his party wants to see economic instability or job losses during the 2018 or 2020 elections.

"The fact that Beijing put soybeans on its list is a signal that China is not going to pull any punches," Christine McDaniel, who served as senior trade economist in the George W. Bush administration, told me.

Many of China's other tariff choices are clearly politically motivated as well, like orange juice, much of which comes from the battleground state of Florida. And tariffs on corn crops could hit swing states in the Midwest like Iowa.

On top of that, experts like William Reinsch at the Stimson Center say that China could take some unconventional steps to interfere with US companies that rely on supply chains in China. Chinese government officials could delay shipments of iPhones out of China or use regulatory crackdowns to interfere with the manufacturing of components that iPhones rely on. That could make iPhones more expensive and hurt Apple's share price.

All of which means a sustained trade war could lead to higher unemployment and slower economic growth in the US. Considering that the pace of the economy has been one of the few bright spots in Trump's tenure, that's a big deal.

So what happens next?

The main thing to watch is the upcoming meeting between Trump administration officials and Chinese officials this week. It's possible they could come to a deal that would result in US and Chinese tariffs being lowered or even taken off the table.

But experts are skeptical that they'll actually manage to come to terms. There's a deep divide within the Trump administration on how to approach the Chinese. Officials like Lighthizer and White House trade adviser Peter Navarro are hawks on China, want big concessions, and favor tariffs, while Mnuchin and National Economic Council Director Larry Kudlow are more inclined to strike a deal with more moderate concessions.

"It's worrisome because you don't have clarity and consolidated negotiating strategy," Levy told me.

The divisions within the administration could make it harder to settle on an agreement with China, and that in turn means that tariffs could be on the way. The question then will be whether Trump will actually deliver on everything he's threatened - and if China will keep up the fight as well.

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The looming US-China trade war, explained

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President Donald Trump is sending his top economic advisers to Beijing this week for talks to avert a possible trade war with China. US Treasury Secretary Steve Mnuchin, US Trade Representative Robert Lighthizer, and other senior economic officials will meet with Chinese officials on Thursday and Friday to discuss the two countries' trade disagreements.

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“Will State Funds for Hong Kong Scientists Spur Innovation or Stifle It?” South China Morning Post, South China Morning Post, 28 May 2018, www.scmp.com/news/hong-kong/hong-kong-economy/article/2148024/will-xi-jinpings-promise-chinese-state-support-hong.

“Xi Urges Special Economic Zones to Serve as Window on Reform.” ChinaDaily.com, China Daily, 13 Apr. 2018, www.chinadaily.com.cn/a/201804/13/WS5ad0b48aa3105cdcf651835a.html.