Hong Kong’s Future Development in a Changing Environment

Tsang Shu-ki

Department of Economics

Hong Kong Baptist University

November 1993

1. The Hazard of Predicting the Future

To predict the future in a volatile world is a hazardous endeavour. To make accurate forecasts about a “small open economy” and, indeed, a “small open polity” like Hong Kong requires no less than a crystal ball. Fifty years ago, who could have imagined a “fragrant harbour” of today’s grandeur and glamour? Speculation about what would happen in Hong Kong in the 21st century may even be politically unwise. Both the Sino-British Joint Declaration and the Basic Law have made it clear that the capitalist system and life style in the territory shall remain unchanged for 50 years after 1997. So what is there to talk about? The “capitalist system”, “life style” are vague terms. If I foresee major changes in Hong Kong’s socioeconomic developments in the years to come and discuss them in detail, I run the risk of giving the impression that I actually advocate them, thus unwittingly challenging a sacred principle in the Joint Declaration and the Basic Law.

Well, so much for the excuses, in case history proves me wrong for the things that I dare say on this topic, which, understandably, can only be highly speculative. It is of course impossible to talk sensibly about the future of Hong Kong without addressing the issue of the territory’s transition through 1997. Let me start by pointing out one obvious irony arising from that transition: the contradiction between politics and economics. Politically, the principle, as enshrined in the Sino-British Joint Declaration and the Basic Law, is straight forward: “one country, two systems”, at least up to 2047. Economically, the reality is one of phenomenal integration. China and Hong Kong are now the largest “outside” investor in each other’s economy. Hong Kong handles the traffic of a third of China’s external trade, while the number of labourers in the Pearl River Delta processing Hong Kong’s intermediate products is larger than the total work force of the territory itself. Even in the early 1980s, these developments were quite beyond imagination.

2. The Political Economy of the Transition

Economic integration would generate demand for some form of political congruence, which, theoretically, is possible under the framework of “one country, two systems” that defines the relations between a central sovereign power and a local government. In reality, there is a number of difficulties in achieving harmonization, given the history of colonialism in Hong Kong for more than a century, the territory’s evolving social profile, as well as recent developments in China and Hong Kong’s varied reactions to them.

We all remember that formal Sino-British negotiation on the future of Hong Kong began in 1982. There has been no plain sailing since then, the achievement of a Joint Declaration notwithstanding. In the midst of hard bargaining in 1983, there was the Hong Kong Dollar crisis, resulting in the present linked exchange rate system, which is increasingly becoming a problem because its desired adjustment involves rising political and economic costs. Then came the controversial drafting of the Basic Law, the 1989 turbulence and its aftermath, the collapse of communism in Eastern Europe and the former Soviet Union, and the renewed row between China and Britain since October 1992.

Let me be as frank as possible on the issue: despite the Joint Declaration, the Basic Law, and all the politicking of the past decade, the concept of Hong Kong as a local government functioning under the sovereignty of China, albeit a reforming one, has still not sunk in for a substantial portion of the local population. People migrate, castigate Beijing, fight for democracy (read “support Chris Patten”), or do nothing but earn money, as much and as quickly as possible¾all signs of unsettled anxiety about “one country, two systems”. Many local residents still do not know what it means to live in a “special administrative region” (SAR) under Chinese sovereignty after 1997.

This kind of socio-political hesitance, or some may call “myopia”, while understandable, is in stark contrast to developments on the economic front. The Hong Kong economy is now so integrated with the Chinese counterpart that the boom and bust in the latter will have a tremendous impact on the territory. It is estimated by the economists of Hang Seng Bank¹ that around a quarter of Hong Kong’s aggregate output in 1990 could be attributed to the China factor. This compares with only 5.3% in 1980, the first full year after China launched its economic reform. Recent developments, particularly in the light of the “Deng whirlwind” of early 1992 and early 1993 and the euphoria over the prospect of China becoming the largest economy in the world by the early 21st Century, would mean that the Hang Seng estimate has to be revised upward rapidly and significantly now and in the near future.

The incongruence between transition economics and politics has already taken an explicit expression: the local business community has almost been unanimous in its stance against the initiatives of Governor Chris Patten on electoral reforms for 1994-95, which caused the present Sino-British row. So much so that Mr. Patten felt compelled to chastise its “short-sightedness” in a TV interview after his second Policy Speech to the Legislative Council in October 1993.

In comparison, the responses of the rest of the society have been mixed. Poll after poll showed that while Hong Kong people in general think that it is a good idea to have more democracy, they also regard as important to have a stable relationship with the Mainland. Some sociologists have called such a phenomenon “ambivalence”, but this symptom of indecisiveness could reflect the trend of polarization in the territory¾people might be forced by circumstances to side with either the camp of die-hard anti-communists and idealistic democrats or that of nationalists and unprincipled pragmatists, in the face of a historical watershed. A survey that fails to handle carefully a “split sample” may confuse dichotomization with ambivalence.

On the other hand, one could argue that the Chinese government also has a good deal to learn in dealing with an advance capitalist SAR under its sovereignty. Its reactions so far, ranging from naive appeasement to arrogant hostility, are in the eyes of many a symptom that it has yet to establish a proper stance towards the people of Hong Kong. Alternatively, they may represent the different attitudes of the “reformists” and the “conservatives’ in the Mainland.

I do not know the true answer to this question of duality. All I can say is that I believe that the contradictions, whatever their nature, are going to persist in the years to come. “One country, two systems” is a historically unprecedented experiment. It would be foolhardy to presume that the rules of the game could be established and settled easily. Time, indeed quite a lot of it, is needed for all parties to adjust their behaviour to the new environment.

One complication is Hong Kong’s changing position in international geopolitics, towards and beyond 1997. The 1997 transition itself is now under clouds. The June 4 tragedy in 1989 and the dramatic collapse of communism in Eastern Europe and the Soviet Union in the subsequent two years substantially altered the diplomatic setting on which the Sino-British agreement on the future of Hong Kong rested. The West’s policies towards China have been undergoing review and changes, as China became the last “communist” bastion and was no longer functional in countervailing the “evil empire” of the former Soviet Union. The current controversy over political reform in Hong Kong, touched off by Governor Chris Patten’s constitutional package of October 1992, is I think part of the readjustment process in the relations between China and the Western powers.

The irony is that China has been able to emerge from the 1989 turmoil and the economic retrenchment in 1989-91, against all the doomsday predictions, and launch a spectacular economic take-off. Adopting purchasing power parity (PPP) methods of re-estimating GDP figures, the World Bank and the International Monetary Fund have recently ranked China as the second and the third largest economies in the world respectively. It is also widely speculated in the popular press that China will overtake the United States as the largest economy in the world by early 21st Century.²

As Alan Donald, the British Ambassador to China in 1988-91, put it,³ the quarrel between China and Britain over Hong Kong is not essentially about democracy and human rights. The nub is the lack of trust between the two parties in the post-cold-war era. The substance of Patten’s package, the functional constituency and election committee proposals, is in my view neither revolutionary nor soundly based on legal and diplomatic grounds. The style of its presentation has certainly been provocative. China’s responses, guided by either a sense of insecurity in the post-communist era or a growing confidence because of increasing economic might, have also been exceptionally stern. Hence the deadlock.

After much ado, the Chinese and British governments engaged in 17 rounds of talks on the electoral arrangements of 1994-95 between April-November 1993. Not many people were optimistic about a breakthrough before the talks started, and hence the break-off in late 1993 did not cause much surprise. Most just regarded it as a political show. Now the chance of the resumption of the talks seems remote, with the unilateral tabling of bills by Patten. Non-convergence increasingly looks likely¾and the Chinese government will set up a “second stove” which prepares for its own version of the SAR government after 1997.

These days there are many optimists who would argue that the negative impact of Sino-British political confrontation and the possible instability of non-convergence has been largely “discounted”, as investors start to get used to politicking between the two sides. The fact that the Hang Seng Index broke all records in 1993 seems to lend weight to their optimism.

The optimists reckon that the key factor affecting the Hong Kong economy is not politics but the fortune of the Chinese economy itself. Moreover, Hong Kong’s economic importance to China is such that whatever the political conflict between China and Britain over Hong Kong turns out to be, China will try its best to separate politics from economics in the transition. Hong Kong may suffer a political backlash after 1997 if the Sino-British deadlock results in confrontation, but the economic goose that lays golden eggs would certainly be taken care of.

All these optimistic discussions of course hinge on the assumption that the stock market is a reliable indicator to the future and that the Chinese economy would progress as many predict. China, despite all its high-growth potentials, is facing a series of very difficult problems ranging from the lack of effective macroeconomic control, cyclical overheating, widening income inequality and regional disparity, to “economic warlordism” (zhuhou jingji), peasant rebellions, rampant corruption, and voids in collective goals. There is no guarantee that Chinese economic take-off will be plain sailing. A collapse is at least theoretically possible.⁴ In that circumstance, which I hope would not materialize, prosperity and stability in Hong Kong would be seriously undermined.⁵

Even if the economic factors remain favourable in the Mainland, the politics of the transition is not that simple. Should there be no convergence, China would have to set up its own version of the SAR government on July 1, 1997. Since selection or elections of the post-1997 chief executive and legislature could not proceed in Hong Kong before that date, given Sino-British confrontation, there might be a temporary political void. Who is going to take care of it?

Moreover, China could feel uncomfortable in dealing with an SAR with a substantial portion of intransigent population, embolden by the last colonial governor who would get away without paying any cost (indeed, earning a good deal of political capital in “standing up to China”). The central government might be keen to teach somebody a lesson. The fact that Hong Kong could serve as a geopolitical leverage for other outside powers after 1997 would only add to the complication. The tension between China and the West that I discussed above will I think last for a long time, and may actually aggravate.

One possible scenario, and I stress that this is just a possible scenario, is that China decides to implement a policy of economic absorption and assimilation of Hong Kong, reducing the latter to a region of economic dependency, in the hope that the SAR’s political bargaining power is as a result commensurately kept within agreeable limits. Any foreign ploy to use Hong Kong as a pawn to destabilize China would also be frustrated. In a way, it would even be advisable to transfer some “portions of prosperity” in Hong Kong inwards, to Shenzhen, the Pearl River Delta, Guangdong, or further north. Hong Kong should continue to be the magical goose that lays golden eggs, but don’t let it get too fat, lest it will be stolen. (Or don’t let its ego expand too much, otherwise it’ll walk or fly away).

At the risk of exposing my ignorance about geography and urban planning, I would give a “practical” example of such a “containment” policy: any “central-place” infrastructure of regional importance should in this scenario be located in Shenzhen or Guangzhou rather than in Hong Kong. Another far-fetched possibility is that the Chinese central government would turn Shenzhen from a special economic zone into a municipality, in the same ranking as Beijing, Tianjin and Shanghai, so as to increase central control over its business, and by very simple reasoning also to exert greater influence over Hong Kong.

I have no wish at all for these to happen, because I do not think that they are the best ways to handle central-local relations in the post-1997 era. Nor are they optimal methods of enhancing economic development in Southern China. Some would certainly doubt the ability of the Chinese government to implement such a coordinated policy in an era of economic warlordism. Others would categorically deny that it has such intention whatsoever.

For the future of Hong Kong and that of China, it is my deeply held belief that a virtuous circle, instead of a vicious one, should be promoted for Sino-Hongkong relations.⁶ Southern China and Hong Kong should cooperate and compete constructively, rather than practice containment or assimilation, which may run against the law of comparative advantage. To set into motion such beneficial dynamics, we need to keep good faith, nurture good will, and build a framework for expanding our complementaries. I hope that my speculation turns out to be totally unfounded. Future historians may find the 1997 issue a minor bump in Hong Kong’s uninterrupted prosperity and China’s march to modernity, while no 21st-century students can earn a Ph. D. by writing a thesis on it.

3. The Economic Integration in Southern China: Benefits and Problems

Let me now go to issues that are more “economic” in nature. As a result of the rapid integration between Hong Kong and Southern China in the past decade, a “structural transformation” has allegedly unfolded in the territory’s economy. While the mutual benefits have been tremendous, serious problems have emerged and important challenges lie ahead.

Let us first look at the issue from Hong Kong’s perspective. Superficial evidence of the “structural transformation” abounds. Manufacturing plants have been relocated to the Pearl River Delta on a massive scale. Over 3 million employees in Guangdong are reportedly working directly or indirectly for Hong Kong. Despite China’s open policy since 1979, the development of her service industries has lagged behind. From transportation to re-exporting to various types of financial and business services, Hong Kong, with its comparative advantage in these fields, has been heavily involved in serving the country’s external economic exchanges. At the same time, development in Hong Kong has reached a level that domestic demand for various kinds of services is substantially increased.

The changes in manpower and output patterns in Hong Kong under such a process have been remarkable. The manufacturing sector and the service sector employed 39.1% and 35.8% of the local labour force respectively in 1980. The latter subsequently overtook the former. In 1991, the share of manufacturing employment was 28.2% while that of services was 62.8%. In terms of output, the manufacturing and the service sectors accounted for 23.8% and 63.2% of Hong Kong’s GDP respectively in 1980. The ratios changed to 15.5% and 73.5% respectively in 1991.

Nevertheless, I think that it is misleading to call such a phenomenon the “structural transformation” of the Hong Kong economy. I have said this elsewhere⁷ and I wish to repeat it here. In the textbooks of mainstream development economics, the shift from an agriculture-based to a manufacture-based economy is hailed as “progress”; so is the trend under which services assume increasing importance over manufacturing in manpower and output shares. The reasoning is that the transformation has been prompted by productivity enhancement in the previously dominant sector (e.g. agriculture), which enables the release of manpower and resources to the “modern” sector (e.g. manufacturing). The development of the latter in turn generates a beneficial feedback to the former (e.g. by facilitating the mechanization of agriculture). A virtuous circle is thus formed, propelling the economy forwards. In the end, a small percentage of the work force can provide enough food for the whole populace. Similar feedback loops are presumably established between manufacturing and service industries in “post-industrial” economies. Japan is frequently cited as an example of information and manufacturing strengths going hand in hand.

It is doubtful whether the present changes in Hong Kong’s employment and output patterns reflect such qualitative improvements. In relocating their manufacturing plants to the Mainland, most Hong Kong entrepreneurs have not been motivated to employ sophisticated technology. Indeed, significant cost savings due to low wage rates and other charges in Southern China have been a powerful disincentive for technological upgrading and, despite short-term gains, may not stand the economy in good stead in the long run. On the other hand, the services that China requires from Hong Kong appear to be of the conventional type. There is a lack of evidence that a virtuous circle between manufacturing and services is being established in the “structural transformation” of Hong Kong’s economy.

The so called “structural transformation” looks more like a case of significant resource re-allocation in the context of regional economics, under which two previously detached areas rapidly remove obstacles to the flow of factors of production and funds. A new pattern of division of labour and cooperation is established, from which significant short-term profits are reaped by both sides. The danger is that these gains are so huge that both are not pressurized to make real structural changes that are necessary for improving the long-run efficiency of the economy. Some economists have used terms such as “hollowing out” and “Dutch Disease” to describe the paradoxical phenomenon of a long-term risk hidden under a short-term bonanza.

In Hong Kong, despite the remarkable economic gains in the past decade, the resulting major problems are:

(a) There is a lack of progress in industrial and technological upgrading and a process of “de-industrialization” has unfolded. These may have serious implications for economic growth, employment, productive efficiency, and balance of payments in Hong Kong in the longer run. A key concern is the possible constraint on the prosperity of a service economy that supports a labour-intensive, export-oriented system in southern China, which lacks technological progress and must therefore face the ultimate limit of market demand for its output some time in the future. Unlike the pre-1979 situation, when Hong Kong had to seriously ponder about industrial diversification and upgrading, the territory’s economy is now so integrated with the Chinese counterpart that it will rise and fall with the latter, as the chance of “de-coupling” diminishes rapidly. Taiwan has been very sensitive about the issues of integration, dependency and synchronicity, while Hong Kong has let all its defense mechanisms fall in an almost sheepish manner.

(b) Inflation is aggravated. Consumer inflation has been hovering around the double-digit level in Hong Kong since 1989, although there have been some improvements lately. The so called “structural transformation” has come into conflict with Hong Kong’s labour supply potential. The fact that the share of services employment in Hong Kong increased by 27.0% between 1980 and 1991 but its output proportion went up only by 10.3% indicates that as the Hong Kong economy became more services-oriented, its overall labour intensity apparently also rose significantly. This partly reflects the slow progress that Hong Kong has achieved in automating its services and replacing manpower with machine power. Such a trend contrasts with the change in the local demographic pattern which has led to much slower labour supply growth, that dropped to an annual average of about 1% in recent years. That inflation would result should hardly be surprising. Moreover, the highest rates of inflation have been observed in the service sectors of the economy.

There is of course another conduit through which inflation can be generated. Most commentators agree that Hong Kong’s GNP, which has yet to be compiled by the government, should be higher than its GDP, which showed much flatter growth in the past years (with an average annual real growth of less than 4% in 1989-1992). The problem is that the gap between GNP and GDP has probably accrued mostly to the investors who make use of cheap resources in Guangdong, rather than the Hong Kong workers. Moreover, any money that is earned in China, repatriated, and spent on assets in Hong Kong would bid up asset prices and, eventually, consumer prices by pushing up the costs of providing consumer goods and services, in so far as these activities use the assets. The same would apply in the case of Mainland funds investing in Hong Kong.

(c ) Income inequality is worsening. The irony is that labour shortage has not unduly benefited local work force in general and there is ample evidence that the income gap in Hong Kong has been widening. On the basis of the changes in the decile or quintile distribution of household incomes as well as the Gini coefficient, a worrying long-term trend of income disparity has emerged. The situation seems to have deteriorated significantly between 1986 and 1991 and Hong Kong’s income inequality is the worst among economies of comparable development levels.⁸ One factor is that the structures of remuneration in the service sectors are usually more disperse than those in the manufacturing industries. The rising importance of the former has therefore contributed to the widening of the overall income gap. The fact that income distribution has deteriorated under labour shortage could also reflect the prevalence of market power, with which monopolistic groups could pass the rising costs, plus an abnormal profit margin, to end-users by charging much higher prices. Another conjecture is that while the economic integration between Southern China and Hong Kong enriches both sides, the distribution of the benefits among various sectors of the population has been rather concentrated and uneven. Many of those who are not involved in “China trade” may actually get worse off, as the “structural transformation” of the economy and high inflation work against them.

Let me now move over to the southern Chinese side of the integration story, because I think that it could shed important light on Hong Kong’s own development. The mirror image is always instructive in understanding oneself. For ease of exposition, I shall concentrate on developments in Guangdong.

Like Hong Kong, Guangdong’s very rapid economic growth has had its own structural problems. The major beneficiary of the past decade of performing processing work for Hong Kong and attracting outside investments has been the Pearl River Delta, which accommodates only one-third of the population in the province. Regional disparity in development appears to have widened. The share of agricultural and industrial production of the Delta in the province rose from 32.7% in 1978 to 57.6% in 1990, while that of the mountain region, which occupies 60% of the land and where 40% of the population live, fell from 16% to 13.4% in the same period. In terms of per capita GDP, the Delta was RMB1106.4 above the mountain region in 1985. The gap widened to RMB2281.5 in 1990. Likewise, the difference in per capita residents’ savings deposits between the two regions also enlarged from RMB548 to RMB2254 in that period.⁹

While Hong Kong relocates its manufacturing plants to Guangdong, thus constraining the real earnings of local blue-collar workers, Guangdong goes through a process, which has essentially the same result, by importing a large number of labour from other provinces. It is estimated that in Dongguan and Baoan alone, about 1.4 million employees from other provinces are working.¹⁰ So Hong Kong is not just utilizing the labour in Guangdong, but also, through Guangdong as an agent, labour in the neighbouring provinces, and indeed all over the country. Just as in Hong Kong, such a possibility of employing cheap labour may bring tremendous benefits, but also serious long-term problems. Income distribution within the province would worsen. The incentives of moving up the technological ladder may also be undermined, as short-term profits keep rolling in.

Theoretically, with the influx of labour from other parts of China, resources and manpower are released in Guangdong and the province could “structurally transform” its economy by climbing the technological ladder and developing tertiary services which help improve the efficiency of the secondary industries. If Guangdong continues to concentrate on doing processing work for Hong Kong and producing labour-intensive products, there is a danger that such a strategy would be overtaken by events. With other parts of China rapidly opening up for outside investments, a good deal of processing investments may go to the north and the interior. Moreover, Guangdong’s hold in the country’s domestic consumer goods market may be undermined, as costs of production escalate and other provinces catch up. Externally, the global market for lower-end products is also characterized by intense competition and rising protectionism. Guangdong simply cannot stay at the same product level indefinitely. It has to move up to higher echelons of the market.¹¹

From official pronouncements, Guangdong in the 1990s is apparently keen to invest heavily in infrastructure and to give priority to the growth of heavy, chemical, equipment and other high-tech industries. The success of such a development strategy depends on many factors. As far as infrastructure investments are concerned, Hong Kong is certainly able to contribute as the territory is now in a position to export capital massively, and many of its constructors and property developers are well experienced in large projects. Hong Kong’s geographical limitation also forms a severe constraint to their long-term growth, and they are only too happy to expand into Southern China. However, for heavy and high-tech industries, Hong Kong would need to re-orientate its own economic development pattern significantly if it is to participate meaningfully in the process.

In any case, whether Guangdong will succeed in its effort to develop heavy and high-tech industries is not easy to tell. The province is poorly endowed with natural resources, and its technological foundation is relatively weak. There is also a lack of large enterprises which can take advantage of the economies of scale.¹² So such an effort would require coordination of policies on many fronts, including investment, enterprise reform, manpower training, taxation, and industrial policies.

An alternative strategy is to turn Guangdong into a large trading and servicing region, providing transportation, communications, marketing, financial and business services to the rest of China. The emphases will then be on building ports and airports, road networks, and communications facilities, as well as developing different types of commodity and financial markets and various tertiary industries such as accountancy, insurance, legal practice, etc. Under such a scenario, Guangdong will be serving China in a manner similar to the way that Hong Kong has been serving Guangdong. The attractiveness of this line of development is that money can be earned rather quickly, and with less risk. It is also more in line with Guangdong’s comparative advantage, at least in the static sense.

The implications of this scenario for Hong Kong are mixed. On the one hand, Hong Kong would be able to participate to a great extent in such a development, particularly in the early stages. It simply means more business for Hong Kong’s already booming tertiary sectors. In the longer term, however, it implies a process of structural convergence between Hong Kong and Guangdong. The big question would then be: does China need a servicing region as large as that of Guangdong-cum-Hongkong? To put it rhetorically: Is it advisable for Hong Kong, Shenzhen, Guangzhou, and Zhuhai each to host an “international” financial futures markets? For Guangdong itself, the strategy would mean following the “natural” course of regional re-division of labour according to “given” comparative advantage. It will however bring long-run problems similar to what Hong Kong has been confronted with: de-industrialization, “hollowing out”, inflation, and worsening income distribution, plus its own version of regional disparity. Moreover, Guangdong is no island economy like Hong Kong. Can the province really feed its huge population (now approaching 70 million) by concentrating on services?

4. A Glorious Future: for Some Only?

A glorious 21st century may be awaiting us. Imagine a Greater China with unprecedented economic prosperity. Driving from Hong Kong to Guangzhou takes two and half hours and to Shanghai thirteen or fourteen on super-highways, and is as pleasurable as speeding from Osaka to Tokyo, or from New York to Chicago (without the traffic congestion, that is).

But will it be a glorious future for a few, or for most of the population?

Under the most “optimistic” scenario, economic integration is total and Hong Kong would serve as the “Manhattan” of a prosperous China in the 21st century. As a side effect, the demand for assets in Hong Kong would undergo a dramatic change: it will be internationalized to an unprecedented extent. In so far as Hong Kong is a stepping stone to the booming China, or a synchronized economic sub-entity, albeit with better facilities and being more market-friendly, foreign investors would be tempted to establish a base in the territory.

Likewise, an outgoing China would put increasing value on Hong Kong as an outpost to the world, not to mention the informal capital flight to the territory that has been gathering momentum. These would translate into strong demands for financial assets as well as commercial and residential property for business operations and for managerial accommodation. China is already the number one “outside investor” in Hong Kong, with total investment estimated to be in the range of US$12-20 billion.¹³

Hence the observation that property prices are beyond “local purchasing power”, which is undoubtedly accurate at least for small-sized and medium-sized flats, would become increasingly irrelevant. The stock market, even without Morgan Stanley’s participatory encouragement, shown recently with much fanfare, could reach new heights that few could now confidently predict.

Under such a scenario, the Hong Kong urban centre in the 21st century would be quite “uninhabitable” for the non-rich, who may be driven out to the cheaper outskirts, or even to Shenzhen and other areas in the Pearl River Delta. A 24-hour customs at the border between Hong Kong and China and commensurate rapid-transit transport would render it possible for the while collars, and the blue collars (if there are any left), to work in Hong Kong but live in the southern part of Guangdong. Whether they like it or not is another story. So are the political implications for “one country, two systems”.

Similarly, overheads and operating costs for business in Hong Kong would be so expensive that only high-risk, high-returns economic activities would find it profitable to be based here. All manufacturing industries will have to go. Even low-returns services need to move out. Again, whether many in the work force can adjust to this “structural transformation” is another story. So are the social implications in terms of income and wealth disparity.

In sharp contrast, the worst-case scenario for Hong Kong’s future development would read like a horror story: China plunges into chaos after Deng passes away. Economic warlordism is compounded by political or even military strife, watched helplessly by a weak and divided Beijing. Refugees flood Hong Kong and the rest of the world. The bubble bursts and a prolonged period of disturbance sets in.

Even in less drastic terms, it is useful to look back into history. The last property euphoria in Hong Kong¾the 1979-81 boom¾saw most property prices triple in three years, only to be halved later in less than two, largely because Deng Xiaoping launched the economic reform and began to open up the country. Now that China aspires something much grander¾to be the largest economy on earth, against a rather depressed global economic scene¾the peak could defy imagination, so would the adjustment.

5. Hong Kong Over-priced, Side-tracked and Further Manhattanized?

Barring the worst-case scenario, we can ask ourselves another question: Is Hong Kong really so important to China? Will it continue to be? Most people can cite off-hand three major functions of Hong Kong in China’s economic take-off, namely, serving as the country’s (1) marketing outlet; (2) external port; and (3) financier. It appears that, in the long run at least, Hong Kong may see a decline in its relative importance in these three aspects. Let me again play the role of the devil’s advocate here.

The concept of Hong Kong serving as China’s marketing outlet is a familiar one, deeply entrenched in the experience of the past decade when local manufacturers rushed to relocate their plants to Southern China to take advantage of its cheap labour resources. The operation in Hong Kong has largely been turned into a managerial and sales centre. This pattern of division of labour is vividly captured in the term qian dian hou chang¾“the shop at the front, the factory at the back”. Obviously, Hong Kong is the dian (shop), and Southern China is the chang (factory). Such a link has worked out very well because of two factors: (1) the factory has been making light-industrial goods that the shop previously made itself; and (2) the shop has a large equity stake in the factory through various forms of investment. These could change in the future if Southern China embarks on its own version of development with much greater emphasis on heavy and hi-tech industries in which Hong Kong has as yet to establish any comparative advantage. Guangdong would form partners with outside foreign investors who may already have their own global distribution networks, hence bypassing Hong Kong, and the territory would lack experience in selling the products of iron and steel, petrochemical, machinery and other high-tech industries that the province may decide to develop.¹⁴

As far as the port function is concerned, Hong Kong is at the moment handling a very large share of China’s external trade. Both the Kai Tak Airport and the container port at Kwai Chung are among the busiest in the world, and the “China factor” is definitely the major driving force. However, China is catching up fast as it enters into an “infrastructure-led, heavy-industries-driven” stage of economic development, which is quite different from the mode of growth in the 1980s. The latter was characterized by rapid expansion of light industries that process and manufacture consumer goods.¹⁵ A large number of highly ambitious plans for the construction of airports, ports, railway and highways has continually been announced by central and local authorities. Those for the Yangtze Delta (centred around Ningbo and Shanghai) and areas around Bohai (from Tianjin to Dalin) are particularly noteworthy as they may form direct competition with Guangdong and Hong Kong.

Even within Greater China, competition is likely to heat up in the future. Shenzhen already has its own airport (Huangtian) and is building a huge port at Yantian. Zhuhai and Macau are constructing their own airports, while Guangdong is going to have a much larger replacement to the present Baiyuan. Even Foshan has had its airfield, which operates commercial flights. Some experts have indeed warned that there are perhaps too many airports in the Pearl River Delta and much better traffic coordination is necessary. Moreover, because of the Sino-British political row, the development of the new airport and new container terminals (CT9 and beyond) in Hong Kong is being affected and delay is quite possible. Whether the delay also fits into the “conspiracy theory” that I put forward in Section 2 above, under which Beijing would see it fit to transfer some of Hong Kong’s functions to other parts of China, is left to the readers to judge. One complication is that a number of the prominent investors in Hong Kong is involved in these huge infrastructural projects in China, and accusations that they may be betraying local interest have been voiced in some quarters.

Hong Kong is undoubtedly playing a very important function in providing external financing for China’s growth and reforms, not just in being its largest “outside” investor, but also in extending bank loans, listing the H shares of some of its largest enterprises, and housing many of the foreign financial institutions which are keen to go into China but need a modern and convenient base. The biggest competitor to Hong Kong is however Shanghai, which is at the forefront of China’s unfolding financial revolution. The city has attracted worldwide attention through its huge development plan for Pudong and the openly stated goal of turning the Bund into the “Wall Street of China”. The fact that Citibank recently moved its China Headquarters from Hong Kong to Shanghai is a clear warning to the territory not to be complacent about its “comparative advantage”.

Some commentators have been much more optimistic about Hong Kong’s economic future. They point to the fact that Hong Kong’s importance as a trade intermediary actually increased in the past fourteen years even as China opened herself to the rest of the world. Various reasons that evoke the theory of intermediation are cited. The gist of the arguments is that Hong Kong can continue to offer services that would reduce the transaction costs for foreigners in doing business with China, because of the territory’s geographical proximity and cultural affinity to China and its “first-mover” advantages such as accumulated experience and economics of scale. Moreover, on the Chinese side, the rise in the heterogeneity of products traded (as a result of development) as well as the decentralized mode of open policy under which local authorities and enterprises have more and more autonomy in conducting foreign trade would increase the transaction costs for foreigners, which Hong Kong with its presumed experience and contact could help to alleviate.¹⁶

While such a view no doubt gives a partial explanation of Hong Kong’s increased importance in the past decade, it is dangerous to extrapolate it into the future without careful analysis. As an explanation it has neglected the simple technical reason that China’s transport and communication facilities could not catch up with its trading volume, and therefore she was forced to route some trade through Hong Kong. With China entering a period of rapid infrastructural expansion and all the ambitious plans of building airports and ports, “diversion” (or more accurately “reversion”, some would say) of at least some trade is inevitable. Moreover, as inflation (particularly asset inflation) continues to surge, Hong Kong is in the danger of pricing itself out of the market. Prices and rental rates of office space are approaching the Tokyo levels, and users are loudly complaining.

Technical factors aside, the economic explanation also needs further investigation. Hong Kong’s connection with China is mainly in the Southern part of the country and concentrates on light industries, i.e. it is at best partial. As far as cultural affinity is concerned, investors from Taiwan (who are now the second largest outside source of direct investments for China) and overseas China in Asia or the West can claim at least equal advantage. For multinational corporations investing in infrastructure and heavy industries, Hong Kong could hardly offer them any service that helps to reduce cost in a significantly way. Moreover, in “using” Hong Kong’s experience and connection, foreigners need not invest in Hong Kong at all. They can just form partnerships with big Hong Kong companies and pour money into China. The impact on the Hong Kong economy could be minimal, unless the profits are massively repatriated by the Hong Kong partners.

These do not mean that Hong Kong would lose all its functions. Nothing like that is going to happen. They do however point to the possibility that Hong Kong might get a smaller share of the pie in the future. But if the absolute size of the pie gets bigger, or much bigger, that should not be much of a worry. What would cause concern is that if significant “diversion” does take place and asset inflation in Hong Kong continues (because of monopoly and profit repatriation), Hong Kong will have to undergo further “structural transformation” to keep ahead of other competing cities and regions in China. In the end, only “high-risk, high-returns” activities would find it viable to be based in Hong Kong. So ironically, Hong Kong will be further “Manhattanized” under such a scenario. The trouble is that only a limited proportion of the population can engage in these activities. The social consequences may be rather daunting.

6. Tackling the Future

Although everything is possible in the future, I have to make a guess. What actually happens will probably be characterized as a case between the “rosy” and the “worst-case” scenarios, and is likely to be nearer to the former. The economic integration in Southern China will in my view go on, and could withstand major political upheavals, unless they are of the disastrous kind. Even if China decides to contain and assimilate the Hong Kong economy or if significant diversion occurs naturally, growth in the future SAR would still be very decent by world standard, at least on average.

If so, the structural tendencies that I described above will become more entrenched. Hong Kong will increasingly be “Manhattanized” (even the recent architectural landscape seems to be suggesting that), if not actually achieving comparable stature. People who are not able to benefit from the “China boom” will be under great pressure and progressively marginalized, while the rich and the super-rich live in glamorous styles.

We should certainly try our best to maximize the benefits and minimize the costs of such a historical course of development. Overall, for the long-term welfare of the territory, I think that a balance has to be struck between industry and service, prosperity and equity, although the temptation to go for where quick profits can be earned is always great, as testified by the experience of the past decade.

Some would argue that the de-industrialization of Hong Kong is nothing to worry about. It is not necessary for Hong Kong to have any manufacturing industries at all. New York has no such industries, so is the case of Tokyo, London, or Paris. Such a comparison is however misleading, because Hong Kong is supposed to be a separate economic system under the Joint Declaration and the Basic Law. After 1997, Hong Kong will continue to issue an independent currency, keep its fiscal autonomy, and determine its own migration policy. So the Hong Kong economy cannot be fully integrated with the Mainland because there will not be totally free flows of monetary, fiscal and human resources.

Hong Kong people will not be able to migrate to Guangdong in the same way that US citizens move from New York to Detroit, so any structural unemployment in Hong Kong cannot be easily solved by an expedient transfer of human resources to the north. In the case of a fiscal or a balance of payments crisis, Beijing is not supposed to come to our rescue. We also have to look after our inflation and distribution problems. In a nutshell, Hong Kong is a very special case of regional economics: it is more like Singapore in ASEAN than New York in the US or Tokyo in Japan, minus the politics of course.

So perhaps Hong Kong should not be the “Manhattan” of Southern China, but its “Shanghai”. A possible mode of operation for Hong Kong’s industries is the combination of China’s capabilities in technological R & D with the territory’s expertise in design, packaging, and commercialization.

Alternatively, Hong Kong, Shenzhen, and Guangzhou could serve as a cluster of “southern Shanghai’s,” with Hong Kong functioning under a special category. Then we should all make genuine efforts to climb the technological ladder and maintain a viable industrial base, which would bring long-run benefits. It would be foolhardy to abandon totally our short-run comparative advantage. Trading and service sectors should no doubt be further promoted, but not one-sidedly. Such a balanced strategy can only be implemented through conscious effort by the authorities with regard to macroeconomic and microeconomic policies, and cooperation by the enterprises and the private sector.

As for the appropriate industrial mix, due to historical and economic considerations, Hong Kong and Southern China need not duplicate Shanghai’s efforts in developing or upgrading heavy industries such as iron and steel, petrochemical and automobile. We should concentrate on the lighter, the less “land-intensive,” the more “skill-and-design-oriented”, and the more “intellectual-labour-intensive” industries such as computers, consumer goods based on the new material sciences, audio-visual and optical products etc. It would be industrialization with “southern China characteristics”. We probably have more to learn from the experience and the planned development strategy of Singapore and, to a lesser extent, Taiwan rather than those of Japan and South Korea. The latter are probably better models for Northern China and Shanghai itself.

Moreover, Hong Kong and Guangdong should coordinate with each other and establish a framework of division of labour, which avoids excessive structural duplication in activities and unnecessary competition, not only in industries, but also in services.

I know that it is not easy to strike a balance between industry and service in Hong Kong. It goes against the prevailing mood of fetching easy money and requires visionary courage on the part of the authority and far-sighted entrepreneurs, which may be lacking around the 1997 transition. So while I would still urge the adoption of a balanced strategy on intellectual grounds, I am prepared to retreat to my second line of defence. I think that problems such as inflation and income disparity, which have arisen from the so called “structural transformation” of the local economy, need to be addressed. Even a more balanced developmental pattern could alleviate but not eliminate them. Reactive and remedial measures by the authority will be necessary to contain their harmful social consequences. If primary market trends cannot be reversed, redistributive and protective measures should become more proactive.

In Hong Kong’s case, a central provident fund (or more logically a pension scheme of the “pay-as-you-go” type), unemployment benefits, capital gains taxes (at least on property speculation), a revamp of the taxation system to introduce higher progressivity and to plug the loopholes arising from the economic integration in Southern China, fair trade and anti-monopoly laws¾to name just a few¾should have been introduced years ago if the government had paid serious attention to the unfolding socioeconomic trends. And even with all these, Hong Kong would still be a long, long way from the social-democratic welfare state of the Western type.

In this regard, the future SAR government in Hong Kong might perhaps be less constrained by the self-imposed laissez faire ideology of the colonial authority, which is increasingly out of touch with reality and in conflict with its own practice. Of course, things could turn worse should “money politics” replace “sanitized colonialism” in the post-1997 era.

The future of Hong Kong is as exciting as it is uncertain. So much depends on our relations with Mainland China and the outside world, and the unfolding patterns of international geopolitics and geoeconomics, which could take unexpected twists and turns, into uncharted territories. However, there is a real chance for Hong Kong to become a great metropolis of the 21st century. Whether it would be one with a human face and one that fits into a rational development framework of a glorious China at ease with itself and the world is not totally outside our control.

Notes:

¹ Hang Seng Economic Monthly, Hang Seng Bank, Hong Kong, June 1993.

² Such estimates and projections have their own problems. Even if they are accurate, there is still nothing much to cheer about. When China surpasses the United States as the largest economy in the world, on PPP calculations, its per capita income would still be one-fifth of the latter’s because of the sheer size of its population, already the world’s largest. See Tsang Shu-ki, “China Becoming the Third Largest Economy in the World?” (in Chinese), Ming Pao, Hong Kong, 16 June 1993, pp.33.

³ Sunday Post, Hong Kong, July 4 1993.

⁴ For a more elaborate analysis of such a possibility, see Tsang Shu-ki, “Loss of Control in China?” (in Chinese), Wide Angle, Hong Kong, July 1993.

⁵ I still think that there is a chance that Chinese authority could “muddle through” the present difficult situation and successfully engineer the economic take-off. The basic reasons include the non-existence of deep ethnic, ideological and religious divisions in the country, and the fact that most people are now fighting for a better life rather for survival, thanks to the foundation built by the gradualist reforms of the past 14 years. If you want a colour TV to replace the black-and-white oldie, you do not kill others for that.

⁶ See Tsang Shu-ki, “The balancing act that few can hope to achieve”, Sunday Post, Hong Kong, 12 February 1993.

⁷ Tsang Shu-ki, “Inflation”, in Joseph Y.S. Cheng and Paul C.K. Kwong (eds.), The Other Hong Kong Report 1992, Chinese University Press, chapter 23, 1992.

⁸ See Tsang Shu-ki, “Income Distribution”, in Choi Po-king and Ho Lok-sang (eds.), The Other Hong Kong Report 1993, Chinese University Press, chapter 19, 1993.

⁹ Yang Ming, “Need for Brand New Thinking, Policy and System” (in Chinese), Hong Kong and Macau Economy, No. 7, 1992, pp.17-18.

¹⁰ Yang Ming, ibid.

¹¹ These problems are apparently recognized by the top officials in Guangdong. See the interview of Zhu Shen-lin, the Guangdong Governor in the report “What are Guangdong’s Pressures, Advantages, Difficulties, and Responses?”, Shenzhen Commercial News, March 16, 1993, p.1 (in Chinese).

¹² Even the most open outpost of the province, Shenzhen, fails to develop much high-tech or capital-intensive industries. See Zhao Zhi-ying, “Why So Few Big Projects of Foreign Investment Settle in Shenzhen?” (in Chinese), Economic Reporter, Hong Kong, October 12, 1992, p.26.

¹³ Hang Seng Economic Monthly, Hang Seng Bank, Hong Kong, October 1993.

¹⁴ The warning to Hong Kong about the need to adjust to the change in the developmental pattern of its “hinterland” was also sounded by another panelist, Prof. Wang Jian, in the same session of this Conference. See his paper “China's Economic Development Plan for the Next 50 Years” (in Chinese).

¹⁵ See Tsang Shu-ki, “The Chinese Economy Marching onto a New Plateau?” (in Chinese), Ming Pao, Hong Kong, 1 & 2 February 1993.

¹⁶ See Sung Yun-wing, The China-Hong Kong Connection: The Key to China’s Open Policy, Cambridge University Press, 1991.

*This paper was first presented in the Conference on “Chinese Cities and China’s Development—A Review of the Future Role of Hong Kong”, jointly organized by the Centre of Urban Planning and Environmental Management and the University Graduate Association, both of The University of Hong Kong, to commemorate the 80th Anniversary of the University. The conference was held on 8-9 November 1993.