Hong Kong’s New Anxiety

As the proposed free trade zone is about to take off in Shanghai, so will Hong Kong have to change. The old days of complacency are over.

Last January, the newly-elected mayor of Shanghai Yang Xion unveiled Shanghai’s plan to develop the mainland’s first free-trade zone, starting in the Yangshan deep-water port, Pudong airport and Waigaoqiao.

In the past, Beijing has approved over a dozen bonded areas, which are prototypes of free-trade zones. But a more extensive zone in Shanghai could bypass that of Hong Kong over time.

Hong Kong’s future depends on adjustment to China’s new stage of growth and the multipolar future.

Tale of Two Cities

The different paths of Hong Kong and Shanghai as rising global financial centers are largely explainable on the basis of historical colonialism and global economic integration. In the 1920s, Shanghai was still the major center of international trade and finance in East Asia. The position of the “Pearl of the Orient” eroded only with the turmoil of the 1930s.

In contrast, Hong Kong has benefited from global integration since the postwar era. After World War II and the Civil War in China, most foreign firms moved their offices from Shanghai to Hong Kong, which also became the home of Shanghai’s entrepreneurial elite.

As textile and manufacturing grew with low-cost labor and population growth, Hong Kong industrialized. The export-led growth model boosted living standards rapidly in the British Crown Colony. Meanwhile, Shanghai was transformed into an industrial center. It became the largest contributor of tax revenue to the central government, but at the cost of crippling its own infrastructure and capital development.

As Shanghai fell into a historical oblivion, Hong Kong thrived, even during the first decade of reforms and opening-up policies because these began in Guangdong. In Shanghai, the development of Pudong was initiated only in 1992.

Nevertheless, even after 1997, Hong Kong enjoyed another extraordinary decade as the financial lifeline of the mainland, due to the level of economic development and relatively closed financial sector in China. However, a new era dawned in March 2009, when the State Council approved Shanghai’s plans to forge itself into one of the world’s leading financial, trade and shipping centers by 2020.

Internationally, these changes were largely discounted as “mere talk” until last January, when the newly-elected mayor of Shanghai Yang Xion unveiled Shanghai’s plan to develop the mainland’s first free-trade zone. This plan, in turn, has been accompanied by financial reforms.

For over half a decade, China’s equity, bond, and currency markets have expanded significantly. New reforms will allow commercial banks to grow their lending, to expand the fragmented bond market, to move gradually toward the securitization of loan portfolios and to open doors to foreign investors and financial institutions.

China’s new leadership needs growth for greater equity, and more sophisticated financial services for consumption-led growth. This is why Premier Li Keqiang fought opposition by financial industry regulators to open Shanghai’s financial services sector to foreign investors.

In this transition, Shanghai will have the driving role as China’s emerging global financial hub.

Hong Kong’s rising pressures

Despite its wealth and capabilities, Hong Kong is increasingly haunted by doubt over the future. After the collapse of the Soviet Union, the Finns relied on a similar intermediary role in the 1990s, but it ended soon as foreign multinationals began to establish subsidiaries in Russia. Over time, economic development mitigates the need for regional intermediaries.

Already in 2010, the IMF noted that Hong Kong’s prospects are overshadowed by unprecedented monetary policy easing in the U.S. and domestic recovery, in part driven by spillovers from the mainland. Both fueled property prices, which could translate into financial risks.

Nor is Hong Kong any longer alone in its quest to capitalize on its status as an offshore renminbi center. New rival cities look eagerly forward to 2015, when Beijing is expected to liberalize the capital account.

In the coming months, the liquidity masquerade will eclipse in the West.  As the Fed will begin to hike rates by the mid-decade, Hong Kong’s property markets must cope with a major correction. Currently, Hong Kong may be overheating, due to ultra-loose liquidity, but China’s decelerating growth and slow global growth will keep GDP growth below trend.

Concurrently, Hong Kong’s competitiveness is eroding. In May, Hong Kong had plunged from China’s second most competitive region to its fifth in a major think-tank survey. A month later, Hong Kong lost its status as the world’s most competitive economy in the annual IMD survey. While Hong Kong has world-class scores in various innovation rankings, the high-tech sector has shrunk as part of export trade.

Instead of looking into the future (read: pushing new emerging industries), Hong Kong continues to rely on its traditional economic legs, such as finance, logistics and trade, tourism, and professional services. However, the latter evolved when China was still a low-income nation, but are now under rapid change.

A few years ago, Malaysia’s strategic advantages began to erode with the rise of manufacturing exports from Guangdong, which contributed to the Malaysia 2020 initiative. Hong Kong cannot avoid similar forces. To sustain its high prices and costly living standards in the future, it needs to boost its high-end advantages.

Sharing the future

Hong Kong can still offer broader and deeper services in trade and finance. But as Shanghai’s free-trade zone will take off, that role will begin relative erosion in the next 2-5 years. The corrosion of human capital relative to that of the mainland will take longer, but that, too, is a matter of time.

Until recently, Hong Kong has thrived as the mainland’s intermediary. But those days are fading. Now it is time for Hong Kong to upgrade and innovate its economic strengths, in cooperation with the mainland. By deeper integration into the Pearl River Delta, it could play a leading role in the expansive regional economy.

The idea that Shanghai is about to become a “mini-Hong Kong” is based on a rear-window outlook of future. In the future, Hong Kong is more likely to be seen as a “mini-Shanghai.”

That is no reason to give in, but all the reason to start anew. That is no reason to fight the future, but to embrace it.

Once, Hong Kong had to learn to thrive without China. Tomorrow, it can excel with the mainland. You don’t have to look back, if you can share in the future.

Dr. Dan Steinbock is Research Director of International Business at India China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore)

A short version of this commentary appeared in the South China Morning Post print edition as “Tale of two cities” (July 29, 2013)

3 Responses to "Hong Kong’s New Anxiety"

  1. Tom   August 6, 2013 at 5:01 pm

    Great piece.

  2. Hkite   August 6, 2013 at 6:41 pm

    One key and critical point: hk government ceased the compulsory education of English in schools. For international trade, English remains the language of choice. Standards have dropped tremendously. Whereas in Shanghai parents are actively putting their children into language schools.
    Language skills have a generational impact: in 5-10-15 years Hong Kong will be less attractive for international business, as the ease of communication decreases, whereas in Shanghai it will have risen. To thrive as an international Center of business and trade, HK needs to return to a city with internationally useful workforce, otherwise it has no advantages versus Shanghai and loses its place as the gateway to China.

  3. jackstraw   August 11, 2013 at 10:58 am

    Hong Kong is still the financial center of all of East Asia…i don't see that changing…especially post fukushima…anytime soon. that says to me Hong Kong real estate will be the most sought after property in the hemisphere for the foreseeable future. Having said that Shanghai obviously offers intriguing geography as the truly massive Yangtze river exits here. In other words you have a gateway to the interior of China which when combined with the dam building spree still going on in China says to me you can create a large "internal growth dynamic" that doesn't exist anywhere in China today.