Your talking points

Satellite photo of Hainan Island, taken by the Moderate Resolution Imaging Spectroradiometer (MODIS) aboard NASA's Terra satellite on November 13, 2020. (Worldview Earth Data / NASA)

Hainan’s unique position makes it a new type of free trade pilot, and the 2025 customs closure marks its shift from policy vision to operational reality.

Hainan is unlikely to rival Hong Kong in the short term (or maybe even the long term)—but that’s not the point.

Hainan offers tariff relief and supply-chain flexibility, not a cure for broader political risks.

For all its promise, Hainan still lacks the institutional depth to absorb complex foreign operations, with early movers largely confined to duty-free retail rather than advanced sectors.

The Brief

In December 2025, China will formally implement the independent customs operation of Hainan Free Trade Port (FTP) (also referred to as “customs closure”), marking a turning point from policy planning to institutional execution.

Unlike previous iterations of free trade zones, Hainan’s FTP is not a limited experiment, but a broader strategic gambit—a WTO-style separate customs territory, designed to function outside China’s traditional customs while remaining within its legal jurisdiction. This model offers new tools to navigate geopolitical headwinds, pilot regulatory innovation, and serve as a lower-risk interface between foreign firms and China’s domestic market.

Beyond the Points

Hainan’s unique position makes it a new type of free trade pilot, and the 2025 customs closure marks its shift from policy vision to operational reality.

With full customs closure set for December 2025, Hainan is moving from a long-term vision to an operationally distinct trade regime. Announced by Chinese President Xi Jinping in 2018, the Hainan Free Trade Port (FTP) is not just another special economic zone, but China’s latest ambitious attempt to create a liberalized trade framework aligned with high-standard global norms.

While preferential trade policies and free trade zones are not new concepts in China, Hainan’s approach is structurally different. Unlike zones such as Shanghai’s Lingang, which remain within China’s national customs and tax territory, the entire island of Hainan is designated a “separate customs territory.” Central to this arrangement is the “two-line” customs framework. The first line manages flows between Hainan and overseas: goods can enter the island duty-free and circulate under zero-tariff, low-tax conditions. The second line manages flows between Hainan and mainland China: only when goods cross into the mainland do they face full tariffs and compliance—unless they meet designated value-added thresholds. This framework positions Hainan as a buffer zone for cross-border commerce, where firms can import components, process or assemble products, and export globally—with reduced exposure to tariffs, national-level approvals, and geopolitical compliance frictions.

This model is made possible by Hainan’s insular geography. As a standalone island with low industrial density, it provides clear physical boundaries to operate a distinct customs regime without constant leakage or enforcement frictions. It also creates an independent regulatory space to test deeper market reforms and model global best practices, while insulating China’s core economic hubs from potential disruption.

Yet Hainan’s geographic suitability also exposes its limitations. Few foreign businesses are currently based on the island, its local manufacturing ecosystem remains thin, and most firms must either trade within Hainan’s small market or rely on shipping to the mainland and beyond. These constraints may limit how far the FTP can advance beyond serving as a controlled testing ground for China’s next phase of opening.

Hainan is unlikely to rival Hong Kong in the short term (or maybe even the long term)—but that’s not the point.

Sanya, Hainan Island (Flickr / Gary Todd)

Given that Beijing has positioned Hainan’s economy around trade, finance, and tourism—mirroring Hong Kong’s own three pillars—it is easy to cast the two as competitors. But for now, Hainan is far from matching Hong Kong’s scale or global reach. Even after the 2025 customs closure, Hainan’s zero-tariff policy will apply to about 74% of goods. Moreover, while goods from Hainan can circulate within the island duty-free—or enter the mainland tariff-free if they meet value-added thresholds—they remain subject to both VAT and consumption tax, which together represent a significant burden. Hong Kong, by contrast, exempts nearly all goods from tariffs, VAT, and consumption taxes, levying duties only on four categories such as tobacco and alcohol.

Yet focusing solely on what Hainan lacks overlooks the deeper strategic distinction between the two. Hong Kong’s economy is overwhelmingly services-based—93% in 2024—with its strengths in finance, trade, and high-value professional services like law and accounting – especially as it moved much of its manufacturing to Guangdong, right across the border. Hainan, by design, is steering toward different engines of growth: advanced manufacturing such as biopharma and NEV components, where bonded assembly can supply the mainland duty-free, and cross-border service sectors like data flows, bonded maintenance, and other high-value processing in 38 approved business categories.

In capital mobility, Hainan is still far behind Hong Kong, making most multinational flows continue to transit through the latter. But Hainan plays a complementary role in China’s broader opening: serving as a controlled testing ground for RMB internationalization. Cross-border transactions in Hainan must settle in RMB, with funds managed through a closed-loop Free Trade (FT) account system. This framework allows Beijing to trial new mechanisms for cross-border capital movement while giving foreign firms lower transaction costs, faster approvals, and more agile pathways into China’s domestic market. This might help to attract the needed foreign firms to make the pilot a success.

Hainan offers tariff relief and supply-chain flexibility, not a cure for broader political risks.

As tensions between China and Western economies intensify—particularly around U.S. tariffs and export controls—foreign firms in China are facing mounting pressures, with foreign direct investment falling to a 30-year low. While Beijing cannot resolve all the concerns of foreign businesses, it is positioning Hainan as a narrowly focused but practical channel to deliver one clear benefit: tariff savings.

By operating outside of the mainland customs territory, Hainan allows companies to import components tariff-free, assemble or process them locally, and—if value-added exceeds 30%—move products into the mainland without tariffs. This mechanism is particularly relevant for advanced manufacturing and renewable energy firms seeking to maintain a China footprint while reducing production costs, whether pursuing a “China-for-China” strategy or continuing to utilize China as a global manufacturing hub.

Still, the benefits are not absolute. Many countries continue to treat Hainan-produced goods as “Made in China,” leaving them exposed to retaliatory tariffs abroad. And Beijing applies its own tariff retaliation policies equally to Hainan. The advantage, therefore, lies less in insulating firms from geopolitics writ large and more in providing a margin of tariff relief and supply-chain flexibility – factors that, while insufficient to resolve broader geopolitical challenges, remain meaningful for firms seeking to manage costs and hedge against uncertainty in today’s environment.

For all its promise, Hainan still lacks the institutional depth to absorb complex foreign operations, with early movers largely confined to duty-free retail rather than advanced sectors.

Sanya, Hainan, China (Unsplash / chantal)

Despite its ambitions, Hainan remains institutionally underdeveloped compared with coastal hubs like Guangdong or Shanghai—let alone Hong Kong. Its most immediate competitors are not global rivals but other Chinese provinces. The island’s economy is still small; its container throughput is even less than 10% of Guangzhou’s, a city just 300 miles away.

Administrative capacity also varies widely. As a historically less-developed, tourism-driven economy, Hainan is still building the rule-of-law foundations it has pledged to strengthen. Dispute resolution mechanisms remain largely untested, and regulatory clarity—particularly around cross-border data flows, capital movement, and tax enforcement—lags behind more mature jurisdictions. Infrastructure, while improving, is still catching up.

To offset these weaknesses, Beijing has granted Hainan a set of narrow but tangible incentives. Beyond zero-tariff imports, the island offers expedited business registration—processes that typically take months elsewhere can be completed in days with minimal paperwork. It has also piloted a “Global Connect” scheme, granting foreign firms access to platforms such as Google and YouTube, otherwise blocked in the mainland. These measures lower entry costs and have attracted early movers. By 2024, Hainan was home to 9,979 foreign-invested enterprises, up 17.5% year-on-year, with more than three-quarters established after Beijing’s 2020 Hainan FTP announcement. The number of investing countries and regions grew from 43 in 2018 to 174 in 2024.

Yet these incentives remain insufficient to make Hainan truly competitive. For manufacturers already embedded in coastal supply chains, relocating production to the island is hardly an obvious choice—particularly when other provinces are also competing aggressively for maintaining them and gaining Beijing’s policy support. As a result, most large foreign entrants so far have been consumer-facing firms—such as LVMH, Richemont, and De Beers—primarily drawn by duty-free retail opportunities rather than production or R&D. High-end manufacturing remains elusive. Tesla’s 2021 pledge to launch a NEV innovation center in the FTP made headlines at the time, but no progress has followed. In practice, Hainan has succeeded in becoming a duty-free shopping haven, but it is still far from realizing its ambition of serving as a hub for advanced industries.

From Blueprint to Reality: China Builds a Free Trade Island for Its Next Ambitious Opening Experiment