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We Have Taiwan At Home
There is a story that Su Shi, the great Song Dynasty poet, was exiled to Hainan in 1097. At the time, this was a death sentence. The island was a malarial backwater, the literal end of the known world, inhabited by "barbarians" and venomous snakes. Su Shi, being a stoic and a gourmand, reportedly (and perhaps apocryphally) made the best of it by learning to cook oysters and writing poems about how nice the weather was. Fast forward a millennium, and the Communist Party of China has decided that Su Shi's place of exile is the future of global capitalism.
On the 18th of December, 2025, Beijing officially "closed" the customs border around Hainan. This sounds bad. Usually, when you close a border, it means tanks are rolling in. In this case, it means the opposite: Hainan is now treated as a separate customs territory for goods, with a "first line" between the island and the rest of the world and a "second line" between the island and the mainland. The Reuters headline calls it a "$113 billion free-trade experiment." The details are drastic, the implications, as far as I can tell, immense. If you are a foreign company, you can ship a wide range of inputs into Hainan, subject to a negative-list regime, tariff-free. If you process those goods there, adding just 30% value under the Free Trade Port's eligibility and supervision rules, you can sell them into mainland China with zero tariffs (while import VAT and consumption taxes may still apply, depending on the product).
This is the "Hainan Free Trade Port", and if the Chinese government is to be believed, it is the successor to Hong Kong, a pilot for joining the CPTPP, and a strategic hedge against a hostile trade war with the US, all rolled into one tropical island.
This is a very big deal. It is also, depending on who you ask, either a big brain play at "dual circulation" economics or a doomed attempt to simulate a free market inside a panopticon. I for one, tend towards optimism.
Let's look at the mechanics, because they are fascinatingly game able. I suspect that might even be the intent:
The core purpose of the Hainan FTP is what we might call the 30% Loophole.
Under normal circumstances, if you want to sell a widget to a consumer in Shanghai, you pay a tariff. If that widget comes from a country currently annoyed with China (or vice versa), that tariff might be punitive. I wonder why tariffs have been a hot topic of late.
Under the new Hainan rules, the flow looks like this:
Imagine if the USGov declared that Florida was a separate customs entity. You could ship French wine or Japanese steel into Miami tax-free. If you turned the steel into a car in Orlando, you could sell it to New York tariff-free.
Perhaps just as important, the tax regime is aggressive. Qualifying firms in encouraged sectors can access a 15% corporate income tax rate (versus the standard 25%), and eligible "high-end" or "urgently needed" talent can be brought down to an effective 15% personal rate via refunds of the portion above 15%. This is a direct shot at Singapore and Hong Kong.
The economic incentives here are powerful. The "30% value added" is a low bar. The accounting details matter: bill of materials, processing costs, overhead; but 30% is low enough that assembly, testing, packaging, and integration often get you there. If I were a German chemical company or a Japanese electronics manufacturer, I'd be looking at this and calculating the margin. You can bypass the Great Wall of Tariffs by setting up a factory in Haikou.
Why is Beijing doing this?
The standard answer is "economic growth." China's FDI dropped ~ 10% in the first three quarters of 2025. The property sector is still a mess. They need a win.
But the specific timing and structure suggest two other motivations: The Hong Kong Problem and The CPTPP Gambit:
Hong Kong used to be the interface between China and the world. It was the airlock. You could keep the mainland pressurized with communism and capital controls, while Hong Kong remained a vacuum of common law and free capital. It worked great until 2019-2020, when the airlock started leaking politics. Beijing has effectively integrated Hong Kong politically, but in doing so, they damaged its unique value proposition. Trust in Hong Kong's distinct legal system has eroded. The "Hainan Option" is an attempt to build a backup airlock.
The theory goes: We don't need the British Common Law or colonial judges to have a financial hub. We can just simulate the economic conditions of Hong Kong (low tax, free trade) without the political pains (protests, foreign judges).
On the other hand:
The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) is the trade deal that the US abandoned under Trump, leaving Japan and others to run it. It has very high standards for data flows, labor rights, and state-owned enterprises.
China wants in. Joining CPTPP would be a geopolitical coup, effectively isolating the US from the Pacific trade architecture. But China, as currently constituted, cannot meet the standards. The state subsidies are too high; the data laws are too strict. Hainan is the "pilot." The Reuters article quotes Vice Premier He Lifeng calling it a "vital gateway." The idea is to adopt CPTPP-compliant rules only in Hainan. If it works, they can tell the trade bloc, "Look, we can do it. There's enough trade in the Pacific without the US wagging its dick at us."
The skepticism here is high. As one diplomat noted in the Reuters piece, CPTPP members generally demand nationwide commitments, not just a gated playground for pilot projects. Beijing hopes Hainan will serve as a proof of concept; trade negotiators suspect it will be a showpiece rather than a structural reform.
Will it work?
If you are a fan of Gravity Models of Trade, you should be bullish (I do not know enough to claim to be an expert, I'm just doing this because it's been a few days and nobody else has bothered). Hainan sits right in the middle of the South China Sea, one of the busiest shipping lanes on earth. It is closer to Vietnam and the Philippines than Shanghai is. If you lower friction/tariffs in a high-gravity area/massive population centers, trade will happen. The physics of economics demand it. If you are a fan of Institutional Economics (think Acemoglu and Robinson), you should be skeptical.
The institutionalist argument is that Hong Kong worked not because of the tax rate, but because of the Rule of Law. If you had a contract dispute in Hong Kong, you knew a judge in a wig would apply English common law, regardless of what the Party Secretary thought.
Hainan does not have judges in wigs. It has the People's Courts. The "Hainan Free Trade Port Law" passed in 2021 promises protection for foreign investors, but we have seen how quickly laws can change when they conflict with "national security."
However, there is a middle path: the "Good Enough" Equilibrium.
Foreign capital might not need perfect British Common Law. It might just need "predictable enough" rules and "high enough" profits. If the 30% value-add loophole generates a 20% increase in net margin for a German carmaker, they might be willing to tolerate the risk that the local court is biased.
Dubai is a good comparison here. Dubai is more chocolate than it is a democracy. It does not have English Common Law (though the DIFC does). But it functions as a global hub because the ruling family understands that screwing over foreign investors is bad for business. If Hainan can establish a reputation for "commercial neutrality", even within an authoritarian state, it could siphon off a lot of the manufacturing-adjacent services that are currently leaving Hong Kong.
There is also the Trump Factor (implied by the fact that 2025 of all years is the date of implementation). If the US is ramping up tariffs on "China," Hainan offers a fascinating shell game.
If a product is made in Vietnam, shipped to Hainan for "processing," and then shipped to Europe, what is its origin? If a product is made in Hainan and shipped to the US, does it get hit with the "China Tariff"?
Probably yes. Customs agents are not stupid (alas). Outside China, origin is usually about substantial transformation or "last substantial transformation," often implemented through tariff classification changes or specific processing rules, not the Free Trade Port's internal 30% threshold.
But for the rest of the world, Hainan offers a way to interact with the Chinese economy without the full weight of mainland protectionism. The "30% value add" rule effectively turns Hainan into a giant mixing vat. You pour in global commodities, stir them with Chinese labor (which is still cost-competitive for high-skill work), and pour out a "Hainan" product. This helps China move up the value chain. Instead of just being the "World's Factory" (doing the scutwork), they become the "World's Processor" (high value add-ons).
Let's look at the numbers again. Hainan's GDP is $113 billion. Hong Kong's is $407 billion. To catch up, Hainan needs to grow at explosive rates. But it has a handicap: talent. Hong Kong is a nice place to live if you like cosmopolitan cities. Hainan is... nice if you like beaches and humidity. But it lacks the schools, the nightlife, and the cultural cachet of HK or Shanghai.
The "talent" question is usually where these top-down economic zones fail. You can build the airport and the office towers, but if the bankers and engineers don't want to live there, you just have a very expensive ghost town. However, the tax incentives for "urgently needed" talent are the counter-weight. In a world where Western nations are talking about wealth taxes and China's mainland tax is high, an effective 15% cap is very attractive. It might attract a specific class of mercenary expatriates and Chinese tech workers looking for a tax haven.
Explain the implications like I'm an idiot, or a precocious 5 year old:
I predict a golden age of smuggling. The "Second Line" (the border between Hainan and the mainland) is the critical point of failure. If you have a zero-tariff zone separated from a high-tariff zone by a ferry ride, the incentive wedge is enormous. Expect the "Second Line" to become a cat-and-mouse game of drone deliveries and mislabeled cargo.
Hainan is geographically closer to Hanoi than to Beijing. The marketing for the FTP explicitly positions it as a gateway to Southeast Asia. If Hainan works, it becomes the de facto capital of the South China Sea economic zone. It pulls Vietnam, Thailand, and the Philippines closer into China's economic gravity well, regardless of the naval disputes.
I suspect this splits the functions that used to be united in HK. It makes HK less indispensable to Beijing, which in turn makes HK more vulnerable politically. Hong Kong keeps the IPOs; Hainan takes the supply chains.
And of course, the Taiwanese elephant in the South China Sea. I get more than a whiff of "we have Taiwan at home", an effort to make a China that is less... Chinese. Perhaps a proof-of-concept that Beijing can take the boot of the neck if you unite amicably.
In a letter from exile in 1097, Su Shi wrote of Hainan: "I have no meat to eat, no medicine for my illness, no house to live in, no friends to visit, no coal for winter, no cool spring for summer. But for some reason, I've got a lot of raw fish. FeelsBadMan." (I am not sure he said any of this at all, I asked ChatGPT for cool quotes. At least Wikipedia confirms he was exiled to the area)
In 2025, you can get all of those things in Hainan, tax-free, likely imported from Australia or France. The fish, you probably want from somewhere with lower levels of mercury.
China is attempting to engineer a free market organ and transplant it into nominally communist body. The rejection risk is moderate. I, for one, am interested in seeing how it all plays out.
China has some of the best legal frameworks in the world for trade, Britain is a terrible jurisdiction for world trade.
China doesn't really care about how you conduct your affairs as long as you aren't openly provoking China. They have no issue doing business with the Taliban, questionable mining companies in Africa, Russians, or Americans. If you can pay you can do business. They don't give a toss about your ESG rating. Wearing a free Tibet shirt when going to court in China isn't advisable but neither is wearing a IRA t-shirt in England.
The experience of foreign companies doing business in China is not this. China absolutely uses threats to Apple's supply chain in China as a tool to influence the output of Apple TV in the US, as an example.
Or to put it another way, "Openly provoking China" sometimes includes saying things which are patriotic boilerplate in your home country.
Yeah. It's hard to make out exactly how bad, given that there's even more of a closed-door culture than the US's terrible backroom deals, on top of the language barrier. But there's very clearly a lot of explicit and implicit pressure going around, and it's not just focused on Chinese domestic or quasi-domestic policies. A lot of it's weirdly arbitrary even to the Chinese.
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