Does Hong Kong have a future?

China only has one Hong Kong, and according to independent researcher Matthew Harrison, its uniqueness is why it should be kept a free gateway to the world.

Editor’s note: This article is an abridged version of Matthew Harrison’s essay of the same title, published on Contemporary Chinese Political Economy and Strategic Relations: An International Journal, which can be read here.

Overshadowed by its increasingly mighty sovereign, Hong Kong seems to have less and less space for surviving on its own terms. The current unrest has dealt a further blow, prompting social division, economic contraction, and emigration. It might still be too early to embrace Fortune Magazine’s 1995 verdict, ‘The Death of Hong Kong’, but witness the South China Morning Post’s more recent column by political consultant Alice Wu, ‘Hong Kong isn’t dead (yet), but it has lost its edge’. Hong Kong seems to be on a downward spiral.

Or is it? To consider Hong Kong’s prospects objectively, we need to look at the territory’s essential proposition and how that proposition serves its stakeholders – especially its sovereign, China.

Whither Hong Kong

This proposition demands definition. From its establishment the territory has been a free port, an entrepôt for trade with China. With Shanghai’s closure following the Communist revolution, Hong Kong became the international gateway to China, a role it has played ever since. This role as the ‘China gateway’ may seem to be fading as China opens to the world. 

But, surprising to some, the nineteenth century concept of an entrepôt linking a closed China to an open world is as relevant as ever.

It’s about service, not stuff

Hong Kong’s entrepôt is no longer mainly about physical goods, yet it is still Mainland China’s fourth largest trading partner, contributing a far-from-negligible 6.7 percent of the latter’s total trade. Hong Kong’s airport, the world’s busiest air cargo terminal, has an international network (170 routes) unmatched by any Mainland airport.

Nonetheless, the entrepôt nowadays is about high-value-added services – financial, management, and professional. Hong Kong is Asia’s leading international financial centre, with 70 of the world’s top 100 banks. Globally, Hong Kong ranks fourth in foreign exchange trading, fifth in stock market capitalization, and first in initial public offerings. In Asia, it ranks first in fund management and third in bond issuance.

Hong Kong’s financial proposition is China-centric. The stock market is the major international listing venue for China enterprises. It is the ‘gateway’ where more than 1,200 enterprises meet international investors. It is also the leading international market for China derivatives. Hong Kong has the world’s deepest offshore RMB pool, settling 70 percent of international RMB payments. Hong Kong also channels more than half of China’s inward and outward foreign direct investment (FDI).

For the 1,500 regional headquarters companies attracted to the territory’s strategic location, its sound legal framework, and its excellent professional and business services, Hong Kong is the window to China and the region.

Overall, Hong Kong provides crucial high-value-added services that China cannot provide for itself. Far from declining in relevance, Hong Kong today is as valuable as ever. China’s development model doesn’t sideline Hong Kong; it reinforces the uniquely vital role the former British colony plays as China’s most valuable entrepôt to the world.

China’s development model needs a Hong Kong (and there isn’t another one)

China’s rapid development since 1978, following the exhaustion of central planning and ‘self-reliance’ under Mao, is based on the policy of reform and opening-up (‘gaige kaifang’: 改革開放). International know-how and resources were harnessed – most via Hong Kong – into special zones which were allowed to experiment in industrial and administrative organisation. The policy was successful, lifting hundreds of millions out of poverty and enabling the nation to become a global power. China is now an emerging middle-income country with per-capita GDP at US$10,000.

This success helped legitimise the rule of the Communist Party (CCP), enabling it to resist demands for political reform. Accordingly, China today is a hybrid; a state-permeated system that retains controls over the movement of capital, goods, services, information, and people, while market-based mechanisms operate throughout much of the economy.

Nonetheless, the continuing legitimacy of the CCP depends on continuing high economic growth. Sustaining such growth, and avoiding the ‘middle-income trap’, is becoming a challenge. The twin engines of growth, exports, and infrastructure spending have both run into difficulties.

Since 2001, China has been exporting under cover of World Trade Organisation membership while restricting access to its own market. Trade partners complain of unfair trading practices including closed markets, forced technology transfer, theft of intellectual property, state subsidies enabling unfair competition, and non-tariff barriers. Heeding domestic complainants about these abuses and more, US President Donald Trump launched a trade war against China in 2018 that continues today. 

Whatever the outcome of the trade war, China’s development model must turn from exports to domestic consumption. This is well recognised in China. Indeed, domestic consumption has risen from a low of 35.6 percent of GDP in December 2010 to 39.4 percent in December 2018. However, exports are still a crucial contributor to China’s growth, and rebalancing of the economy will take a long time.

The other growth engine, infrastructure investment, has boosted productivity. However, there have also been many wasteful projects, contributing to a rise in national indebtedness to 248 percent of GDP by March 2019. The externalities of rapid growth in preceding decades, such as depleted water resources, pollution, and climate change are also catching up on policy-makers. Meanwhile, the population is ageing rapidly as habits ingrained by the former one-child policy prove entrenched. Relaxation of the policy and even government exhortations to procreate have failed to deliver an increase in birth rates.

Facing this daunting complex of problems, the Chinese leadership has narrowing options. Two options it has promoted to allow continuation of the present development model are the Belt and Road Initiative (BRI) and ‘Made in China 2025’. However, in the medium to long- term, they will prove insufficient to changing the fundamental challenge China faces in escaping the middle income trap and ensuring the continued legitimacy of the CCP.

Extension via Belt and Road

Based on an Economic Belt recalling the historic Silk Road between China and Europe, and a notional Maritime Silk Road through the Indian Ocean and beyond, the BRI focuses on infrastructure investment to connect less-developed countries with the world economy – especially the economy of China itself. Through the BRI, China aims to gain influence over participating nations and, at the same time, acquire new markets for its excess production, so potentially extending the lifespan of its export-driven model. 

However, delivery of BRI projects has proven problematic. Less-developed countries like Pakistan and Sri Lanka need infrastructure but lack the means to pay for it. Many BRI initiatives fail to generate profits to pay for themselves. Chinese lenders who provide financing have faced accusations of making unpayable loans so they can seize strategic projects (i.e. ports in key naval locations) when the bill is due, creating a form of 21st century Chinese neo-colonialism.

The employment of Chinese workers rather than local workers and use of China-sourced materials, rather than those from local suppliers, upsets local sensitivities. There are also allegations of bribery, opaque project terms, and debt-trap diplomacy. At home, some ask whether the resources going into the BRI would be better spent within China itself.

Overall, it is hard to see the BRI constituting an informal Chinese empire. The BRI countries are too diverse and too far-flung. In any case, China lacks the deep bench of internationally experienced personnel that would be needed for an imperial enterprise.

Extension via ‘Made in China 2025’?

In the case that the BRI ultimately offers no external escape from China’s looming development trap, the 2015 campaign, ‘Made in China 2025’, may be another option. This plan seeks to ensure that China becomes a top world manufacturing power by 2049, and implies self-reliance in key sectors that could allow for more, not less, closing of China’s borders. Its feasibility is in question.

The Chinese leadership recently moved to downplay ‘Made in China 2025’ as the plan’s protectionist overtones upset trading partners. A more fundamental flaw than outside concern is that the plan is not realistic.

In international trade, to quote President Xi’s own words, China is ‘big but not strong’. It produces goods which are of medium quality and price but falls short on the increasingly important inputs of service and design. With an underdeveloped service sector, China will be hard-pressed to make up for this shortfall. China is highly dependent on international inputs, particularly US-developed software and microchips. Import substitution for these is imaginable, and indeed the state is investing in chip manufacture. Yet substitution cannot be done for everything.

Self-reliance implies the loss of the benefits of trade based on comparative advantage. The associated benefits of exposure to overseas best practice are also lost. Self-reliance is ultimately a route to poverty as demonstrated by examples such as Cuba, post-independence India, North Korea, and China itself under Mao. Long before such extreme conditions were reached, the CCP would lose the Mandate of Heaven in the eyes of the people.

Opening via enclaves

If neither the BRI nor ‘Made in China’ self-reliance offer a way out, China faces a dilemma.

To continue high economic growth and escape the middle-income trap, China needs international inputs; not only goods, but increasingly the services and structured information that are critical to a modern developed economy. China will need international capital too, since its current account will likely trend into deficit as consumption rises. However, international providers of services, information, and capital are difficult to control. They require law-based protection and the right of withdrawal; they stimulate ideas and discussion. Nationwide opening-up under a law-based framework is difficult to reconcile with CCP hegemony.

If nationwide opening-up is ruled out, there remains opening in selected areas via the enclave model. This, too, has been recognized by the leadership. From 2013, Free Trade Zones (FTZs) have been created in Shanghai, Guangdong, and other regions. However, the FTZs are too small and piecemeal to make a difference.

Nonetheless, the enclave model represents China’s best hope of sustaining growth without undermining the state-permeated system. Enclaves of some form or another may be the only route to a future that is acceptable to both the Chinese population (promising economic growth) and its leadership (allowing control). What form these enclaves should take is up for debate.

If Hong Kong is the ultimate economic enclave, it begs the question of a proliferation of FTZs could replace Hong Kong’s traditional and vital role.

HK and the rest

A comparison between the existing FTZs and Hong Kong is instructive. Unlike the FTZs, Hong Kong is:

  • Of sufficient economic size to be self-sustaining and make a difference even to the vast China economy;
  • A complete societal system, with its own executive, legislature, and courts;
  • Highly autonomous vis-à-vis the central government;
  • Properly founded on its own constitution, the Basic Law;
  • Governed by the rule of law adjudicated by an independent court system;
  • Delineated by clear physical and legal borders from the rest of China so that experimentation within the enclave is containable;
  • Operated in accordance with free market principles.

Only an enclave structured like Hong Kong could deliver benefits on a Hong Kong scale. Mainland China has nothing like Hong Kong. However, areas that are somewhat more open today, such as the Greater Bay municipalities, could make a start. Shenzhen is already slated for further experimentation.

Implications for Hong Kong

The promulgation of the enclave model on the Mainland would not be, as some suppose, the end of the Hong Kong experiment; in fact, it would be positive for Hong Kong.

First, it would be a strong endorsement of the Hong Kong system. Second, with its 170 years of experience, Hong Kong would become chief among the enclaves; the leader of the flying geese. Third, Hong Kong would be the model for China’s future.

Fourth, such enclaves would provide healthy competition. If anything Hong Kong is too secure in its China gateway role. There is a dearth of competition, which breeds complacency in Hong Kong’s leadership and rent-seeking behaviour among its conglomerates that political leaders enable. More competition from Shenzhen, for example, would prompt more creativity. Last, but not least, new enclaves would provide more development space for Hong Kong.

Conclusion

Overall, there is a very convincing case for Hong Kong’s prosperous future. In its gateway role the territory performs immense service to both China and the international community, not to mention its broader prowess as an international financial centre and a management headquarters and professional and business services centre for the Asia-Pacific region.

Even this impressive catalogue is not the full statement of Hong Kong’s value. For in its enclave role, Hong Kong represents the only viable model for China to transit to a more developed status. China needs more Hong Kongs; it should cherish the Hong Kong that it has.

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the author

Matthew Harrison is an independent researcher and writer on financial and economic matters.