Chapter 7.49: Hong Kong - China s Special Administrative Region

Chen Dou, Senior Researcher and Director General, Hong Kong and Macao Research Institute Translated by Li Yong

Overview

In recent years , Hong Kong's economy has been besieged by serious recession and sustained depression. There are external as well as internal reasons for this. External factors mainly include the aftermath of the Asian financial crisis, the impact of the September 11th terrorist attacks and the overall slowdown of the world economy.

Internally, there are three key factors:

1. The bursting of Hong Kong's economy's pre-1997 'bubble'. In the mid-1980s, following clarification of its political future and the speedy development of economic and trade relations between Hong Kong and the mainland, Hong Kong's economy entered the ascending period of a new cycle which reached its peak in 1997. However, behind its flourishing appearance, a 'bubble economy' took shape in Hong Kong's property and stock markets, the two important pillars of its economy. The unusual rise had in effect prepared for the unusual fall that has taken place since the last quarter of 1997.

2. 'Hollowing' of Hong Kong's industrial structure. Hong Kong has been in a 'post-industrial' period since the mid-1980s. Its manufacturing industry, another of its economic pillars, was under pressure caused by increasingly scarce land and labour resources and sharp rises in production costs, which prompted a large-scale relocation of the industry into Southern China, typically the Guangdong Pearl River Delta area. In the process, for reasons such as the generally small sizes of manufacturing enterprises , weak technological capability and the non- intervention policies of the then British government of Hong Kong, the region's manufacturing industry failed to upgrade and transform its structure, which was manifested in the trend of 'hollowing'.

3. Structural unemployment as a result of industrial relocation, together with the negative assets and northward consumption shift caused by the aftermath of the Asian financial crisis, has led to a sustained weakness in consumer spending, which in turn has seriously deterred the recovery of the territory's economy.

During the Asian financial storm , Hong Kong's economy was hit hard. Although the pegged exchange rate of Hong Kong dollars was maintained , laying a foundation for economic recovery, the pressure of the expensive costs, particularly the adverse effects of the currency depreciation on neighbouring Asian countries and regions , made the upgrading and transformation of Hong Kong's industrial structure increasingly important and imperative, not only for the SAR government, but also for the business community and Hong Kong society as a whole. In fact, the SAR government, after China's takeover of the territory, corrected the shortsighted and short- term behaviour of the Hong Kong British government and began to look at Hong Kong's economic transformation from a strategic point of view. In his first Policy Address delivered in October 1997, the Chief Executive of Hong Kong, Tung Chee Hwa, explicitly stated that, with the northward relocation of Hong Kong industries, 'the invisible hand of market forces has already pointed the way forward: to develop high value-added industries and services'. In the new historic period, the upgrading and restructuring of Hong Kong economy in this direction is in effect a natural course of development. Such an effort involves two important and interrelated issues, the repositioning of Hong Kong's economy and the upgrading and restructuring of its industrial structure.

After the return of Hong Kong, Tung Chee Hwa confirmed in his second and third Policy Addresses, the positioning of Hong Kong as an important city. He said 'Hong Kong has the potential to become not only a major city within one country but also the most cosmopolitan city in Asia, enjoying a status similar to that of New York in America and London in Europe.' He pointed out that:

Hong Kong already possesses many of the key features common to New York and London. For example, we are already an international centre of finance and a popular tourist destination, and hold leading positions in trade and transportation. These are all pillars of our economy. If we can consolidate our existing economic pillars and continue to build on our strengths, we should be able to become world-class. Then, like New York and London, we will play a pivotal role in the global economy, be home to a host of multinational companies and provide services to the entire region.

This positioning has received support and affirmation from the general public.

Closely related to the repositioning of Hong Kong's economy is the upgrading and restructuring of its industries. The Commission on Strategic Development, chaired by Tung Chee Hwa, issued a report entitled Bringing the Vision to Life: Hong Kong's Long- Term Development Needs and Goals which concluded that if Hong Kong is to achieve its goal of becoming the most cosmopolitan city in Asia and a major city in China in the next 30 years, several sectors and areas are key to its long-term development and its likelihood of maintaining its strong regional and international competitive advantage. These include sectors such as financial and business services, tourism, multinational corporations (MNC) regional headquarters, information services and telecommunications, innovation and technology, trade, transportation and logistics and creative and cultural activities. Among these, innovation and technology will undoubtedly be the new emerging industry in the economy, which will in turn equip other industries in Hong Kong.

Since globalization and the knowledge-based economy have become major trends in the development of the world economy, it is inevitable that Hong Kong, if it is to elevate its position in the Asia Pacific region and the global economy and to become the New York of Asia, must shift its whole economy to a high valueadded one, pivoting on the development of a knowledge economy driven by innovation and information technology. In fact, under the active auspices of the SAR government following the Asian financial storm, Hong Kong's economy had begun such a transitional shift, one proof of which was the 'one-after-another' investment in information technologies by large enterprises and publicly listed companies in Hong Kong.

It should be recognized, however, that there is still a considerable way to go before Hong Kong can truly become 'the most cosmopolitan city in Asia'. Hong Kong is facing strong competition from powerful Tokyo, aggressive Singapore and rapidly emerging Shanghai within Asia. From a global perspective, only one country “ the USA “ has succeeded in transforming its post- industrial society into a knowledge-based economy. Japan has put 10 years of effort into that aim but is now struggling on the fringe of economic recession. The four Asian Dragons, including Hong Kong, Singapore, Chinese Taiwan and Korea, are lingering in the shadow of sluggish economies. The underlying reasons for this are manifested in their consequences. In terms of Hong Kong, the generally small sizes of the enterprises, the investment culture's preference for short-term high returns, weaknesses in science and technology, a shortage of talents in research and development and a narrow market, combined with a long-practised tradition of non-intervention by the former Hong Kong British government, all these have made Hong Kong's successful transition into a knowledge-based economy driven by innovation and information technology a difficult task, and there is a long road ahead before Hong Kong can reach this goal. The burst of Hong Kong's network technology bubble in 2000 has underlined the severity of the challenge.

Hong Kong's economy now seems to be experiencing a period of painful structural readjustments. In the short term, no industry has been able to play a driving role in the economy. This is why Hong Kong's economy has not been able to emerge from the bottom of its economic recession. For this reason, the recovery of its economy or the return of its prosperity need organic coordination of short-term, mid-term and long-term development strategies. However, cooperation between Hong Kong and its economic hinterland, Guangdong Pearl River Delta area is essential, whether a short- to mid-term effort to stimulate investment and consumption, or a mid- to long-term effort to elevate its base of innovation and technology.

Since the economic reform and opening up of the mainland, economic cooperation between Hong Kong and Guangdong has resulted in world-renowned achievements which have proved an important element in supporting the sustained development of Hong Kong's economy.

At the beginning of the 1990s, however, this cooperation came to a state of logjam, indicating that its foundation was weakened. This weakness was manifested in two ways. The first was the way in which the limitations of cooperation have gradually become apparent. After China's accession to the WTO, the implementation of 'national treatment' will be expedited, which will gradually reduce the preferential treatment that Hong Kong investors enjoyed in the past. At the same time, large numbers of foreign companies and products have flooded the mainland of China and Chinese enterprises have also gone into overseas markets. This means that products made by Hong Kong-invested enterprises are subjected to fierce competition from imported products in the mainland market, while in the overseas markets they are to face the threat of products made by mainland enterprises. In the face of such changes, labour-intensive manufacturing operations by Hong Kong investors will inevitably encounter pressure from capital- and technology- intensive industries. If Hong Kong investors fail to achieve a successful transformation of the region's manufacturing industry, the cooperative model of 'store in the front with factory in the back' between Hong Kong and Guangdong is likely to be challenged.

The second aspect of the weakening Hong Kong- Guangdong cooperation is the further shift in Hong Kong from entrep t to offshore trade. China's accession to the WTO will stimulate sharp increases in its foreign trade, which will bring more trade opportunities. But, challenges still exist. As explained in the report by the Research Department of Hong Kong Trade Development Council, 'in the face of the changes in China and the rest of the world, Hong Kong's role as the mainland's trade hub will undoubtedly undergo fundamental changes'. With the reforms in China's trade system, and the opening up of the country, foreign companies will have complete access to trading and distribution rights. They will be more inclined to consider direct entry into or direct purchase from China. As a result, Hong Kong's entrep t trade will further shift to offshore trade, and the traditional role of Hong Kong as an entrep t port will be diluted.

However, there have been signs since the beginning of the 21st century that a new period of cooperation has begun and has quickly gathered pace, thanks to pro- active efforts by the governments of Hong Kong SAR and Guangdong and their respective business communities. This new round of cooperation has occurred against various macro-economic backgrounds. Internationally, economic globalization and regionalization have become the leading trends of world economic development, and regional competition is becoming a key feature of modern times. Domestically, China's entry into the WTO will lead the country into a new era of all-round opening up, expedited economic reforms and gradual integration with the world economy. In this way, trade and investment interactions between China and the rest of the world will be speeded up and the flow of materials, capital and information will be accelerated. In addition, the rapid emergence of southeast China, centring on Shanghai and the beginning of a grand development programme for western China have made both Hong Kong and Guangdong aware of the absolute necessity of strengthening their cooperation in this new historic period.

With this new macro-economic background, and within the general framework of the WTO, new territories have emerged for the economic co-operation between Hong Kong and Guangdong. In particular, China's accession to the WTO will further accelerate the pace of opening-up of the service sector, which will undoubtedly bring a new round of development opportunities for Hong Kong's service sector. Those who stand to benefit the most, among others, are financial services, telecom and Internet services, freight forwarding and logistics, wholesale and retail, professional services, advertising and tourism. Of course, the level of benefit for different sectors will vary according to their different situations. Moreover, they will also confront fierce competition from multinationals coming from overseas.

Three sectors have strategic implications:

Logistics

After the accession to the WTO, China will for the first time open up distribution rights to foreign companies in areas such as wholesale, retail, transportation and repair services. All restrictions relating to the service sector, such as leasing, express delivery, freight handling, warehousing, technical inspection and testing and distribution and packaging services, will gradually be lifted. Large multinational logistics enterprises will quickly enter the Chinese market. This will offer new opportunities for the cooperation between Hong Kong and Guangdong. The problem here could be that, if Hong Kong is to be the key regional logistics centre, it will face competition from other central cities such as Shenzhen and Guangzhou., The essential question, therefore, is how Hong Kong can integrate its resources. If Hong Kong is able to establish itself as the most important logistics centre in the region, and to strengthen its position as such, it will undoubtedly be conducive to reinforcing the region's links with the Guangdong Pearl River Delta area, which has the reputation of 'world plant'. This will in turn advance the 'store- in-the-front-with-factory-at-the-back' mode of cooperation into a new period.

The financial sector and intermediary commercial services

Hong Kong, as a financial centre in the Asia Pacific region, has a complete and developed financial system and a large pool of industry talent. It is an important channel for international capital to enter China, as well as for Chinese enterprises with regards to financing and stock floatation. With China's accession to the WTO, Hong Kong's financial institutions, for historical and geographical reasons, may well capture the Guangdong market. If the financial services corridor that consists of Hong Kong, Shenzhen and Guangzhou can be extended to the whole of Guangdong, the level of economic integration between Hong Kong and Guangdong will be greatly enhanced. In addition to this, other intermediary services such as accounting, surveying and consultancy will also find promising development prospects in Guangdong.

Cooperation and coordination between the industries of Hong Kong and Guangdong will result in the upgrading and transformation of the current industrial structure into high value-added and hi-tech industries. Since the mid-1990s and into the 20thcentury, hi-tech industries in Shenzhen have rapidly expanded, laying a solid foundation for the coordination of industrial upgrading and transformation between the two places. If Shenzhen could learn from the experiences of the San Francisco Bay area and rely on the well-known universities and research institutions in northern China to retain a large number of hi-tech talents in the area, while at the same time taking advantage of Hong Kong's position as an international financial centre to introduce international venture capital institutions to the area, Shenzhen would become a powerhouse for coordinated industrial upgrading and transformation between Hong Kong and Guangdong. Establishing a Hong Kong-Shenzhen science and technology corridor will help form a Hong Kong-Pearl River Delta hi-tech industrial belt.

Under the new conditions, particularly within the framework of the WTO, Hong Kong and Guangdong are likely to cooperate on a new basis. The economic integration of Hong Kong, Macao and the Guangdong Pearl River Delta Area will be greatly accelerated and become an important driving force for the recovery and sustained development of Hong Kong's economy.

Of course, challenges and opportunities co-exist in the cooperation between the two sides, and competition is also embedded in this cooperation. The key issues that should receive special attention are:

1. Hong Kong and Guangdong should actively promote regional economic integration and accelerate the process of establishing an unrestricted two-way flow of production factors, including capital and people, within the region. By doing this, Hong Kong will be able to strengthen its position as the most important service centre in southern China.

2. The barrier of an economic border between the two places should be reduced as far as possible in order to lower transaction costs in the cooperation of the two sides. Since the 1990s, along with the overall development of economic and trade relations between Hong Kong and Guangdong and increasing exchanges of people between the two sides, the checkpoints at the border have become a transportation bottleneck. Serious congestion of vehicles and people has become a major hindrance for economic co-operation between the two regions. Indeed, with the principle of 'one country two systems' and Hong Kong being China's special administrative region and an independent tariff zone, the border in its political sense should be respected and protected. At the same time, however, effort should be made to reduce the barrier of the economic border between the two places, in order to lower the expensive transaction costs arising from the border barrier. Recently, both Hong Kong and Guangdong have extended the opening hours of the border crossing. 24- hour border crossing is being considered by both sides and a proposal for the construction of a sea bridge linking Hong Kong, Macao and Guangdong has been revisited. These areas are aware of the level of urgency required to solve the problem.

3. A multi-level and regular coordination mechanism should be established. In the past 20 years, economic cooperation between Hong Kong and Guangdong was mainly market-driven and promoted at an unofficial level. In the present climate of increasing economic integration in the region, however, policy coordination and institutional arrangements between the governments of the two places will be critical. Although Hong Kong and Guangzhou have now established a coordination mechanism of high-level joint meetings, the practice of such a mechanism in the last few years has proved that as it exists it is a long way from meeting the objective demands of economic cooperation between both sides. The two governments should consider setting up standing coordination agencies which, with the authorization of the central government, will coordinate all key issues regarding the regional cooperation between the two places. By doing this, problems arising from cooperation may be practically and effectively solved , thereby facilitating the process of economic integration.