Reflections on the economic future of Hong Kong.

• Author: Hagelin, Ted
• Position: Symposium: Hong Kong's Reintegration into the People's Republic of China

Mah jiu paau. Mouh jiu tiuh.

The horses will go on running.

The dancing will continue.

Deng Xiaoping's Pledge, in Cantonese,

to the People of Hong Kong(1)

1. INTRODUCTION

   The reunification of Hong Kong, one of the world's premier free market economies, with the People's Republic of China (hereinafter P.R.C.), one of the world's last remaining communist states, is an unprecedented political feat. Never before has a communist country attempted to absorb an autonomous, fully developed capitalist economy. Change of this magnitude inevitably creates great uncertainty. Every step is a first step, sometimes forward and sometimes backward. The three areas of uncertainty that have preoccupied observers of Hong Kong are politics, economics, and the relationship between the two.(2) Other contributors to this symposium have considered the possible political consequences of Hong Kong's reunification. This Article will focus on the realm of economics and will comment on the state of other institutions only as they impact Hong Kong's economy.

   The economic consequences of reunification for Hong Kong are a matter of great concern for investors around the globe, but especially for those in the United States. The United States is Hong Kong's second largest trading partner after China.(3) Additionally, Hong Kong is currently the world's eighth largest trading economy and tenth most important exporter of services.(4) Hong Kong imported fifteen billion dollars worth of goods from the United States in 1995, representing an increase of nearly thirty percent over 1994.(5) The United States is the second largest investor in manufacturing in Hong Kong, with eighty-eight factories, over eighteen thousand workers, and $2.6 billion in sales in 1995.(6) Hong Kong is also vitally important to U.S. transPacific trade, which totalled $409 billion in 1994, more than fifty percent greater than U.S. trans-Atlantic trade.(7) Finally, Hong Kong is a major gateway for U.S.-China trade, with forty-two percent of U.S. exports to China and sixty percent of U.S. imports from China passing through Hong Kong.(8)

   This Article attempts to gauge the economic future of Hong Kong. Many disparate factors serve to shape a country's economy and direct its future course. These factors, which span the realms of military, political, legal, economic, and foreign policy affairs, are carefully assessed by investors to determine the aggregate risk exposure associated with an investment in a given country.(9) Investor assessment of these environmental risks then determines the minimum level of financial return required on an investment in one country as opposed to another.(10) Although these risks are often amorphous and difficult to quantify, international financial markets reduce these risks to a very specific rate of return. Ultimately, the greater the risk, the greater the return required by investors and the higher the cost of capital to a country. Today, countries around the world compete for international investment funds. Those countries which can provide low risk, stable investment environments will attract more international capital at a reduced capital cost. This is the context in which this Article examines Hong Kong's economy.

   Recognizing the hazards of prediction and following Shakespeare's prescription that the past is prologue to the future, this Article first briefly reviews Hong Kong's economic history and current economic circumstances. It then considers the positive and negative influences on Hong Kong's economy. This discussion is organized around a number of different environmental influences, which are likely to contribute positively to Hong Kong's future economic growth. Then, the Article reviews some particular events, which the author believes could have a negative Impact on growth. This discussion covers an array of concerns raised in the context of the unique tripartite relationship that exists among the United States, Hong Kong, and China, as well as by the relationship among the United States, Taiwan, Japan, and South Korea.

   The overall balance of these circumstances points to a highly favorable investment climate in Hong Kong for years to come, but there are events that could cause a precipitous downturn in the Hong Kong economy. The United States has an important role to play in encouraging stability and growth in Hong Kong, and in Southern China generally. The prime beneficiaries of a carefully crafted U.S. trade policy for the region would be U.S. businesses, especially small and medium-sized companies.

2. HONG KONG'S ECONOMY: PAST AND PRESENT

   Signs of prosperity abound in Hong Kong from the number of Rolls-Royces and exclusive shops to high-rise office buildings and never-ceasing harbor reclamation projects. First-time visitors to Hong Kong often compare it to New York City, and there is a striking similarity between the Hong Kong Island skyline viewed from the Tsim Sha Tsui promenade and the Manhattan skyline viewed from the Brooklyn Heights promenade. Closer inspection, however, reveals an important difference between the two metropolises. Unlike that of Manhattan, the Hong Kong skyline is composed of ultra-modern buildings, few over twenty years old. The modernity of Hong Kong, reflected also in its transportation systems and public facilities, reminds one that Hong Kong's prosperity is of relatively recent origin.

   1. Early Economy

      During the millennia of governance by Imperial China, Hong Kong was primarily a fishing village with a subsistence economy.(11) A rocky island with steep hills, Hong Kong was merely one of hundreds of other islands scattered throughout the Pearl River estuary and was considered of little importance to China or to foreign explorers of the time. Hong Kong was either omitted or unrecognizable on Chinese maps of the Ch'ing period (1644-1911) and did not appear on any maritime charts until 1760.(12) The Portuguese, who were the first European explorers in the region in the sixteenth century, chose the Macao peninsula, on the other side of the Pearl River delta, over Hong Kong as a settlement site. Hong Kong, however, did offer foreign travelers a safe port while waiting for the annual change in the prevailing winds in the South China Sea, but only at the risk of attack by the numerous pirates who also took shelter in the many coves and bays of the Pearl River estuary.(13)

      The great commercial center of Southern China at that time, and the principal destination of foreign traders, was Canton. Situated at the headwaters of the Pearl River some seventy miles upstream from Hong Kong, Canton was the gateway to mainland China. Foreign trade through Canton in 1831 was estimated to be nearly $50 million, with opium by far the largest foreign import, and tea and silk the largest foreign exports.(14) The ceding of Hong Kong to Britain in 1842, followed by the ceding of the Kowloon Peninsula in 1860, and the ninety-nine year lease of the New Territories in 1898 were the result of Britain's insistence upon free trade in opium backed by overwhelming military force.

      Hong Kong's economy expanded during the early colonial period, but was still primarily dependent upon the opium trade with mainland China.(15) This was the era of the great British trading hongs fictionalized in James Clavell's novels.(16) The two largest of the original hongs were Jardine Matheson and its arch rival, Dent's.(17) Over time, the hongs expanded the scope of trading activities beyond opium (although Jardine Matheson to this day uses the poppy flower as its corporate logo) and developed extensive docks and warehouses on the Hong Kong Island side of what had become Victoria Harbor. All in all, however, the first hundred years of British rule of Hong Kong saw only modest economic growth based almost entirely on shipping and trade, as well as smuggling.

   2. Economic Expansion

      The first stimulus to a manufacturing economy in Hong Kong came during the 1950s when Hong Kong's role as a trade entrepot for southern China was suddenly terminated by a United Nations declared blockade of China.(18) Hong Kong's fledgling manufacturing industries, many led by immigrant Shanghai businessmen,(19) grew throughout the 1950s, primarily producing inexpensive toys, textiles, and low-end electronic products. The Vietnam War gave further impetus to Hong Kong's expanding manufacturing base through the 1960s. However, it was not foreign events, but social chaos in China, that irrevocably altered the course of Hong Kong's economic future.(20)

      During China's Cultural Revolution (roughly 1963-1976), millions of mainland Chinese fled to Hong Kong to escape the ravages of anarchy and economic deprivation.(21) The new immigrants gave Hong Kong an abundance of low-wage labor, which quickly attracted foreign investment in a variety of new manufacturing plants. Although relatively low skilled, Hong Kong's immigrant labor pool possessed a boundless determination to succeed, and the discipline and dedication necessary to master new skills.

      It was during the decade of the 1980s that Hong Kong's economy finally reached its full potential.(22) This growth was fueled not only by the maturation of Hong Kong's labor force and economic institutions, but also by changes across the border in China. With the ascension of Deng Xiaoping in 1979, China embarked on a series of radical economic reforms. Foremost among these reforms was the establishment of "special economic zones" (hereinafter SEZs), which were to operate as free trade centers to attract foreign investment and technology. Shenzhen, across the border from the New Territories and a less than an hour train ride from Kowloon, was designated by Deng as the first of the SEZs. The impact on Hong Kong was immediate. Shenzhen offered a new, low-wage labor pool, inexpensive land, and substantial tax advantages. Investors in Hong Kong quickly began moving their manufacturing operations to Shenzhen, and Hong Kong began the transition...