Hong Kong: The Market of the Future or No Future SOURCES: This case study was written by Ilkka A. Ronkainen and funded in part by a grant from the Business and International Education Program of the U.S. Department of Education. The assistance of the U.S. Consulate in Hong Kong, Inchcape Pacific, the Customs and Excise Department of the Hong Kong Government, the Hong Kong Trade Development Council, and the Hong Kong Economic and Trade Office in Washington, D.C., is also appreciated. For additional information, see http://www.info.gov.hk. T he People’s Republic of China (PRC) and Hong Kong are inextricably linked. Looking at the past, there are abundant reasons for the relationship to be one of pride and fear (see Table 1 for a time line). In fact, many will argue that Beijing never recognized Hong Kong’s separation from the mainland after the Opium War in 1842. As a result of long-standing economic and cultural relationships—primarily between southern China and Hong Kong—some considered the reunification of July 1, 1997, mainly a symbolic flag-raising ceremony. What that symbolism meant is debated. “Hong Kong took over China, not the other way around,” says a representative of the Hong Kong Trade Development Council, while an American businessman well entrenched in China and its system warns: “Hong Kong may be the scapegoat for what Chinese leaders perceive as Western injustice.” Although recent Eastern European history offers numerous examples of command economies giving way to market-oriented systems, it is difficult to predict what will happen in the long term when a command economy—the PRC—takes over an unbridled bastion of capitalism—Hong Kong. “There are bound to be, on both sides, uncertainties, and there are bound to be suspicions,” said Sir David Wilson, governor of Hong Kong from 1987 to 1992. “This whole process is something which is unprecedented in terms of world history. There are no international historical blueprints to go by. We have to find our own way.” However, by the third anniversary of the reunification, the consensus is that very little has changed. The 1984 Sino-British Joint Declaration and Basic Law that returned Hong Kong to Chinese sovereignty in 1997 makes it a Special Administrative Region (SAR) of China for at least fifty years, presumably enough time for the two political and economic systems to mesh. China has also pledged that Hong Kong would be run largely by its own people under the concept of “one country, two systems.” This means continuing the system of an elected government, rule of law, independent courts, and wide personal freedoms. The SAR will be run by a chief executive selected among longtime Chinese residents of Hong Kong. Hong Kong will remain a free port and separate customs territory and will be able to decide on and conduct its own economic policies. This will be evident in practice through Hong Kong keeping its own currency and retaining its separate membership in the World Trade Organization (WTO). Hong Kong as a Business Center Hong Kong is the world’s tenth largest trading nation and the third largest financial center. In an area of just over 400 square miles, it has a population of 6.2 million. Its per capita income is over $25,300, second in Asia after Japan. It’s the world’s largest free port and top-ranking manufacturer and exporter of textiles, clothing, and toys. No other business center in the Asia-Pacific is as friendly to business, offering free trade, free enterprise, a welleducated work force, a policy of “positive nonintervention” in trade matters, and low taxes. Hong Kong has been ranked by the Heritage Foundation as the freest economy in the world consistently throughout the 1990s. For a summary of Hong Kong economic facts, see Table 2. The economy as a whole is externally oriented and its growth and well-being depend mainly on its trade performance. Apart from trade in goods, trade in services also contributes significantly to Hong Kong’s growth. Given its strategic location and well-established infrastructure and business contacts, Hong Kong has developed into a center for trade, finance, communications, and business services for the entire AsiaPacific region. The Hong Kong government plays no favorites, putting foreign policy and locally owned companies on the same footing. While there are no special incentives offered to overseas business to relocate, formalities to setting up a business are kept to as few as possible. There are no regulations concerning the minimum capital requirement of a company, or any regulations concerning the relative degree of local/overseas participation in the ownership of the company. The Hong Kong government assists in finding suitable local partners for joint ventures. Likewise, there are no regulations concerning the relative proportion of local to overseas staff that may be employed. Typically, however, the high cost of living (i.e., mainly housing) discourages companies from using a large number of expatriates. There are no restrictions on foreign exchange or on transferring capital or profits in or out of the colony. The Economic Interdependence of Hong Kong and China Existing Hong Kong–PRC economic ties will set the pattern for future developments. The PRC is currently Hong Kong’s largest trading partner and its main source of investment capital. Hong Kong has evolved as the “International Division of China Inc.”—both in managing China’s exports and importing foreign goods for re-export to China. Approximately 70 percent of China’s annual exports to the United States pass through Hong Kong in the form of re-exports. Hong Kong’s established business and social connections with both China and the rest of the world, excellent telecommunications and transportation facilities, and financial sophistication make it uniquely suited to its role as facilitator. An important part of this facilitation is to serve as an intermediary in trade between China and Taiwan. Since the PRC implemented an “open door” policy in the 1980s, Hong Kong’s and outsiders’ economic importance to China has increased. There are now 84,000 foreign-funded enterprises in China, most of them in the south. These enterprises are estimated to account for 25 percent of all of China’s foreign trade. The economic development of southern China—especially the Pearl River Delta in Guangdong Province and the coastal economic zones—has been the catalyst for China’s economy to grow by almost 10 percent a year since 1978. Guangdong Province itself has for the last ten years averaged real annual growth of a stunning 15 percent. Although the province has less than half a percent of China’s land and a mere 16 million of its 1.2 billion people, it accounts for 5 percent of total industrial output and 10 percent of exports. Per capita income in Guangdong Province is roughly $600, double that of China as a whole. The star of the province is Shenzhen, a city across the border from Hong Kong, set up as a special economic zone by Beijing in 1979. Shenzhen residents enjoy rapidly increasing per capita incomes of $800, which is expected to increase to $2,800 by the year 2000. Figure 1 provides a summary of the major business centers of the Pearl River Delta. During its thirty-year-old drive to attract foreign direct investment, estimated total realized investment reached $220 billion. About 60 percent is estimated to have come from or through Hong Kong. A full 80 percent of Hong Kong manufacturers have set up labor-intensive production facilities across the border. Hong Kong companies operating in Southern China now employ about four million people—more than ten times the number of manufacturing sector workers in Hong Kong itself. More than 60,000 Hong Kong managers, professionals, technicians, and supervisors are currently working in China. In addition, 20 percent of Hong Kong’s currency circulation takes place in Guangdong Province. At the same time, China is increasing its stake in Hong Kong. China is the biggest investor ($25 billion) in the economy, ahead of the United States and Japan, with major investments in the aviation sector (e.g., a majority ownership in Cathay Pacific), telecommunications, and property. As a matter of fact, it is estimated that PRC buyers controlled 20 percent of the Hong Kong property market by the time the takeover occured. The Bank of China, which is the second largest banking group (after Hong Kong Bank) in Hong Kong, currently issues Hong Kong’s currency notes, fully backed by foreign exchange deposits with the Hong Kong government. China’s Economic and Consumer Boom Economic growth in China has been rapid: GNP growth has been over 10 percent consistently in the 1990s. China’s exports totaled $183 billion, imports $140 billion, resulting in a trade surplus of $43 billion in 1998. Despite the austerity measures introduced in the summer of 1993 to cool down the economy, strong growth is still continuing. This growth is bringing affluence to many parts of China, not just the major cities, such as Guangzhou, Shanghai, and Beijing. Examples of the changes this growth is bringing include: Retail sales in China surged 10 percent in the early 1990s to approximately $200 billion. By the year 2000, annual retail sales are projected to have reached $600 billion. Department stores display a wide variety of consumer goods and are overflowing with eager consumers. Traffic through some of China’s department stores is well over 100,000 people per day. For a working couple in Guangdong Province, monthly household income may be 1,200 yuan ($210). Although Ferrero Rochet chocolates sell for 68 yuan, and a pack of Brand’s Essence of Chicken is priced at 100 yuan, they sell very well to a broad range of customers. While incomes in China are low by Western standards and by those in the developed economies of the Asia-Pacific, the proportion of disposable income is high as are savings. Living expenses take only 5 percent or less of family income in China, while the comparable figure in Hong Kong is 40 percent. There is tremendous pent-up demand for consumer goods among the population, who have had nothing to spend their money on for many years. Private savings are high even by Asian standards and amount to one-third of an average worker’s annual income. Chinese consumers are quality conscious. Jointventure products (such as Head & Shoulders, Tang, and Pepsi-Cola) are perceived as quality items and often command double or triple the price of goods produced solely by Chinese companies. In developing a strategy for China, companies such as Inchcape Pacific (which acts as a marketer and distributor for many companies including Cadbury’s, SmithKline-Beecham, and Kellogg’s) consider approaching China as one big market a mistake. Inchape’s priority markets are Southern China (Pearl River Delta), Eastern China (Shanghai, Nanjing, and Hangzhou), and North China (Beijing, Tianjin, and Dalian). The rationale is that each is a very separate and different market from the others in terms of people, culture, dialect, way of life, climate, and diet. Most importantly, each is a huge consumer market in its own right. The sheer size and the logistics problems make national distribution in China an impossibility. Taking advantage of this opportunity requires flexi-bility. Changes in the regulatory environment create both opportunities and challenges. Contacts have to be cultivated beyond the central government in Beijing. Provincial and municipal authorities enjoy autonomy and influence and tend to be quite entrepreneurial. The municipal government usually supports or has very close links with a few companies in its area. A potential entrant needs to develop good relations with these officials and the business leaders in the local companies. Hong Kong–U.S. Business Links The overall key to Asia is access—access to markets and market information. For many U.S. companies, Hong Kong’s strategic location, developed infrastructure, and commercial expertise provide the best bang for the buck in Asia. Markets in Asia, China in particular, lack a solid legal framework for business and rely more on personal relationships. Leading overseas Chinese entrepreneurs can be invaluable facilitators because they operate through a network of personal contacts. Procter & Gamble, for example, got into the Chinese market in 1988 by forming an alliance with Hong Kong businessman Li Ka-shing. More than 900 U.S. companies have operations in Hong Kong at present, more than double the number of five years earlier. Virtually every Fortune 500 company that does business in the Asia-Pacific region maintains a presence in Hong Kong, usually a regional headquarters. A good example of this is Polaroid Far East Limited. A wholly owned subsidiary of Polaroid Corporation, Polaroid Far East Limited’s Hong Kong office is headquarters for a region that covers South Korea, Singapore, Malaysia, Taiwan, China, Indonesia, Thailand, and India. The Hong Kong office, which opened in 1971 and now has sixty-nine employees, controls finance, sales and marketing, and personnel. Hong Kong is a major market for U.S.-made goods in its own right. As a matter of fact, Hong Kong imports more U.S. goods per capita than any country in the world—four times the level of Japan, five times that of Europe. Some of the major categories of traded goods can be found in Table 2. Hong Kong also represents a convenient stepping-stone to China. Polaroid recently announced a manufacturing joint venture in Shanghai to produce consumer cameras for export. In addition to manufacturing cameras, Polaroid hopes to develop the Chinese domestic market for document photography. Hong Kong’s role is to provide training for the new operation in China as well as sales and marketing support. C. C. Chan, sales and marketing manager for the Polaroid Far East China Trade Department, thinks most people in the PRC are still unfamiliar with free market Western-style business. “Hong Kong brings China closer to the world,” says Chan. Some of the other firms in the market are: Campbell’s Soup, which opened a $500,000 R&D center to spearhead its thrust into the Asia-Pacific. The new center will be developing a wide range of canned products for the Chinese palate. The operation is also intended as a springboard into China. Motorola, the world’s fourth largest semiconductor manufacturer, opened a multimillion-dollar stateof-the-art chip-manufacturing plant in Hong Kong. The plant will supply the entire Pacific Rim, which is a $14 billion market for semi-conductors. Waste Management International has a 70 percent stake in a consortium that won a multimilliondollar contract to build and operate Asia’s first chemical waste treatment facility in Hong Kong. The Other Side of the Coin: Macro and Micro Challenges Hong Kong’s economy suffered badly as a result of the June 4, 1989, crackdown on student dissidents on Tiananmen Square. “The events reminded people of the uncertainty, risk, and lack of predictability in dealing with Beijing,” says Robert Dorsee, vice president and managing director of Tyco (Hong Kong) Ltd., a division of American-owned Tyco Toys Inc. The concerns grew as the changeover on July 1, 1997, got closer. In October 1992, the present governor of Hong Kong, Chris Patten, put forth proposals that would further democratic reform in Hong Kong by allowing more participation by the Hong Kong Chinese in the selection of members of the local legislature (the Legislative Council). The Chinese government objected ferociously on the grounds that major changes were a violation of the Joint Declaration, and that the proposed reforms were in breach of the Basic Law. Rhetoric from Beijing went as far as to suggest that the treaty with Britain be “scattered to the wind,” and even that China might grab control over the colony even before 1997. Although discussions were held to resolve the disagreement, the confidence of people both in Hong Kong and those interested in investing there was shaken. For example, the Hong Kong Electronics Association, whose members do most of their manufacturing in the crown colony, sponsored trips to the Philippines, Malaysia, and Thailand to study the climate for new investments in those Asian nations. One of their concerns was that export control rules would cut their access to Western technology once China took over. China’s rough tactics also endangered its already shaky most-favored-nation (MFN) status with the United States, and the discussion of moving to “permanent and normal trading relations.” The latter concern points out the fact that the greatest threat to Hong Kong may not come from China but from the United States. China’s trade surplus with the United States reached $56.9 billion in 1999 (up from $24.9 billion in 1993), a major irritant in the countries’ trade relations. In October 1992, the two governments reached an agreement on market access (so-called 301 investigation), under which China pledged to liberalize its foreign trade regime. About 75 percent of the nontariff barriers were eliminated by 1994, the rest by 1997. Tariffs would also be reduced. The agreement did not, however, clear the way for China to join the WTO, as differences of opinion still remain between China and the United States, as well as the EU. If China loses its MFN status with the United States because of its human rights record or concerns over protectionism, military goods exports, and intellectual property, Hong Kong will suffer the most. This is why a special Hong Kong Business Mission has lobbied in Washington for the renewal of China’s MFN status every time it has been up. U.S. exports would also suffer as China would undoubtedly retaliate with higher tariffs. When China lost its bid to host the 2000 Olympic Games, U.S. exporters worried about negative trade measures as a response to the opposition to the bid by the U.S. Congress. Similarly, when the Chinese embassy in Belgrade was accidentally bombed in 1999, many worried about the long-term effects on U.S.–China trade. In the long term, many hope that the statement by Lu Ping, director of China’s Hong Kong and Macau Affairs office, holds true in the positive sense: “Hong Kong is bound up with its Motherland. It will serve as a bridge, channel, and window between China and the rest of the world, and play its unique and positive role in China’s development in the next century.” Whatever happens, Hong Kong is a Special Administrative Region of the People’s Republic of China. Beijing will determine whether Hong Kong remains and grows as an open international business hub. It is already the unofficial commercial capital of the Overseas Chinese. For U.S. firms, Hong Kong will be the place to find appropriate partners and connections to enter the Chinese market. In many ways, Hong Kong’s roles are, and continue to be, critical, as seen in the summary provided in Table 3. However, if Beijing reneges on its guarantee that Hong Kong can retain its position as China’s capitalist gateway to the world, not only will Hong Kong become a back-water for global business, but China itself will be hurt in terms of attracting foreign direct investment and its most-favored-nation status with the United States. QUESTIONS FOR DISCUSSION 1. Would you agree or disagree with the following statement from the U.S. Information Agency in Hong Kong: “The reality, beyond the newspaper headlines, is that China is not going to kill the golden goose.” 2. What are Hong Kong’s benefits for a Western company that would make a move to the Philippines or Thailand undesirable or difficult? 3. Provide a possible strategy for a U.S. company operating in Hong Kong to leverage against political risk. 4. What are the benefits of using Hong Kong as a base for entering and marketing in the Chinese market? REFERENCES Auerbach, Stuart. “Toy-Making Losing in China Some Appeal.” The Washington Post, December 2, 1989, D11–13. The Basic Law of the Hong Kong Special Administrative Region of the People’s Republic of China. Hong Kong: The Consultative Committee for the Basic Law of the Hong Kong Special Administrative Region of the People’s Republic of China, April 1990. “Campbell Soup Targets Asia with New R&D Center.” Business International, January 27, 1992. Cheng, Paul M. F. “Gateway to Greater China.” Sydney, Australia: Presentation made to the 36th CIES Annual Executive Congress, April 22–24, 1993. “China at a Boiling Point.” The Economist, July 10, 1993, 15. Conley, Kirsta. “Hong Kong: Business Center of the Future.” Export Today 7 (February 1991): 20–22. Country Report: China, Mongolia, second quarter. The Economist Intelligence Unit, 1993. Establishing an Office in Hong Kong. 6th ed. Hong Kong: The American Chamber of Commerce in Hong Kong, 1989. Johnson, W. Todd. “Hong Kong Exporter’s Gateway to China.” Export Today 7 (June 1991): 18–22. Joint Declaration of the Government of the United Kingdom of Great Britain and Northern Ireland and the Government of the People’s Republic of China on the Question of Hong Kong. Hong Kong: Hong Kong Government Information Services, December 1984. Kraar, Louis. “Asia 2000.” Fortune, October 5, 1992, 111–142. ———. “Storm over Hong Kong.” Fortune, March 8, 1993, 98–105. ———. “Strategies that Win in Asia.” Fortune, Fall 1991, 49–56. Mutch, Andrew J. “Hong Kong: Tapping into the Dynamic Dragon.” Export Today 9 (January/February 1993): 30–34. Setting Up Business in Hong Kong. Hong Kong: Hong Kong General Chamber of Commerce, 1990. Worthy, Ford S. “Where Capitalism Thrives in China.” Fortune, March 9, 1992, 71–75. TABLE 1 Hong Kong and China: A Time Line 214 B.C. China Takes Hong Kong China colonized Hong Kong under emperor Qin Shi Huangdi—the powerful ruler in the north credited with first uniting the kingdom. However, Hong Kong remained a backwater. 1842 The Opium War China ceded Hong Kong island to the British under the Treaty of Nanjing. Subsequent treaties gave Britain permanent use of Kowloon Peninsula in 1860 and a ninety-nine-year lease of the New Territories starting in 1898. Chinese consider this period one of national shame and weakness. THE 1900s Hong Kong Emerges as a Port Hong Kong’s role as a transit port to China grew, as did its population, swelled by refugees fleeing civil war and the Japanese invasion of the mainland. Hong Kong boomed in the post– World War II era, and a class of Chinese business leaders emerged. 1949 Communism Sweeps the Mainland The Communist victory on the mainland resulted in an exodus to Hong Kong of many of China’s capitalists, landowners, and entrepreneurs. Later, China’s failed economic policies cause more people to cross the border. 1978 China Opens Up, Hong Kong Cashes In Economic reforms by Deng Xiaoping included special economic zones, one of which is across the border from Hong Kong, and businesses from the territory were the first to invest there. While benefiting from the transit trade, Hong Kong started changing into a financial center. 1984 The Sino-British Joint Declaration The agreement between China and Britain provided for the return of Chinese rule under a “one country–two systems” scheme. Hong Kong is to pay no taxes to Beijing and will remain a free port and financial center, with laws left unchanged for fifty years. Tiananmen Beijing’s military crushed pro-democracy protests and cast a dark shadow across Hong Kong’s return to China. 1989 The Basic Law The National People’s Congress—China’s lawmaking body—passed the Basic Law for Hong Kong, which is to become the constitution after the changeover. A broad article on treason could undermine other promises made in the document. 1990 1992 Face-Off with Beijing Electoral reforms made by Governor Chris Patten turned relations with Beijing sour, complicating projects such as the new airport at Chek Lap Kok. 1993 A Key Arrest Beijing arrested Hong Kong–based journalist Xi Yang while he was reporting in the mainland and sentenced him to twelve years for subversion. This sent chills through the press in Hong Kong. 1995 Democrats Win Elections Under the new election scheme, Democrats won 16 of the 20 directly elected seats in the 60-member Legislative Council. Beijing swore to disband the council in 1997. The Shadow Government Beijing’s response to the election was to form the Preparatory Committee—a group of 150 handpicked mainland officials and Hong Kong residents. Working parallel with the Legislative Council, it selected a 400-strong body of Hong Kong people who, in turn, chose the post-1997 chief executive to replace the governor of Hong Kong, shipping tycoon Tung Chee Hwa. 1996 The Handover On midnight July 1, a joint ceremony in the new convention center marked the “dignified departure” of the British. A provisional legislature, chosen by the Preparatory Committee, took the place of the Legislative Council. Tung Chee Hwa becomes first chief executive. 1997 Hong Kong Elections The first major test of Beijing’s hands-off promise occurred when Hong Kong residents went to the polls for the first time in the postcolonial era. 1998 1999 Portugal Returns Macao Macao returned to China December 31, 1999. Beijing is trying hard, alternating with carrot and stick, to forge a reunification agreement with Taiwan. SOURCE: “Coming Full Circle,” MSNBC, October 21, 1996. For more information refer to http://www.scmp.com. TABLE 2 Hong Kong Essential Facts POPULATION 6.2 million GDP PER CAPITA $25,300 FOREIGN EXCHANGE RESERVES $57 billion TOTAL EXPORTS $173.4 billion DOMESTIC EXPORTS $29.5 billion RE-EXPORTS $143.9 billion IMPORTS $193.3 billion U.S. EXPORTS TO HONG KONG $11.6 billion U.S. IMPORTS FROM HONG KONG $35.2 billion PRINCIPAL U.S. EXPORTS Electrical machinery, resins and plastic materials, transport equipment, office machines, tobacco manufactures PRINCIPAL U.S. IMPORTS Garments, electronics, office machines, photographic apparatus, electrical machinery U.S. INVESTMENT IN HONG KONG $13 billion U.S. EXPATRIATES IN HONG KONG 23,500 U.S. FIRMS WITH OFFICES/ 900 PLANTS IN HONG KONG CHINESE INVESTMENT IN HONG KONG $25 billion HONG KONG INVESTMENT IN CHINA $133 billion FIGURE 1 The Fastest-Growing Economy on Earth SOURCE: Ford S. Worthy, “Where Capitalism Thrives in China,” Fortune, March 9, 1992, 71. Copyright © Time, Inc. All rights reserved. TABLE 3 Hong Kong’s Possible Roles (before and after 1997) Hong Kong will continue developing its entrepôt role—as the international marketing arm of China. Hong Kong is not just the world’s gateway to China, it is also China’s springboard to the world. Hong Kong has the knowledge and experience of international business; through Hong Kong, China can better understand how international business operates and what the expectations are. Hong Kong will continue acting as a broker for international firms looking to set up in China, often in three-way joint ventures. Hong Kong will continue to provide a secure base for capital. Hong Kong could also develop as China’s own “Silicon Valley,” providing R&D for China’s expanding industrial sector. In the information arena, it can become the “cyberport” of Asia. It can also train mainland staff in Hong Kong or provide on-the-job training in China. Hong Kong’s role as the link between Taiwan and China will also continue in the foreseeable future. Adapted from Stephen Clark, “Hong Kong’s Role in the Development of Greater China,” presentation given July 30, 1993, Chinese University of Hong Kong. SOURCE: