Hong Kong's economy continues to be depressed by deflation and high unemployment. It is only the vibrancy of China's economy that is propping up the territory's reputation as a commercial and trading hub.
Hong Kong's former brash self-confidence has given way to doubt and self-examination as it grapples with its second economic downturn in five years and tries to redefine its relationship with an increasingly prosperous mainland China.
The economy has suffered in line with slower global growth. GDP rose only 0.6 per cent in 2001 compared with 10.2 per cent in 2000. Trade remains a key driver but is facing structural challenges. Export growth in the first eight months of 2002 was a lacklustre 0.9 per cent, as the territory struggled to recover from the fall-off in global trade after the September 11 terrorist attacks.
A key challenge, and one that has emerged more quickly than expected, is the rise of competition from lower-cost ports on the mainland. Hong Kong is still the world's busiest port thanks to its middleman role in handling trade to and from China. But this role is diminishing. Hong Kong today handles only about 35 per cent of the mainland's foreign trade compared with 55 per cent five years ago, prompting some commentators to describe the ports sector as a 'sunset' industry for the territory.
The bright side is that the SAR's role as an air-freight hub for southern China is growing. Air cargo volumes have risen on average 10 per cent a year since 1997 despite the tough economic conditions. As mainland factories increase production, the demand for reliable international air cargo services has grown. Hong Kong's international airport, Chek Lap Kok, has an edge over rival mainland facilities because the territory is able to negotiate airline treaties directly with foreign governments. Other Chinese cities have to rely on the central government in Beijing for this function.
While there are pockets of good news on the trade front, the territory's domestic economy remains locked in recession. Once the engine of the economy, property prices are 65 per cent below their 1997 peak. Numerous government attempts to intervene by reducing the amount of subsidised housing available have had little impact.
Deflation, meanwhile, was entering its 46th consecutive month in October 2002. The problem, which began with the depreciation of currencies in neighbouring countries during the Asian financial crisis of 1997/98, is now considered to be structural. Hong Kong's currency board system, under which the exchange rate is fixed to the US dollar, means the territory must adjust to changes in its international competitiveness through price shifts. Many believe that as China opens up following its entry to the WTO in 2001, Hong Kong prices will have to continue to fall to make up for competition from the mainland.
The long period of economic downturn has pushed unemployment rates to new highs. Unemployment for the June-August 2002 period was 7.6 per cent, down from a peak of 7.8 per cent earlier in the year but high compared with pre-crisis levels of 3 per cent. There is concern that higher levels of unemployment may now also be structural. To remain competitive, the territory is aiming to move up the value chain by providing more sophisticated professional services to industries on the mainland. However, only 13 per cent of Hong Kong's workers have university degrees, about half the average for the developed world. Large numbers of unskilled or low-skilled workers will need to retrain or risk long-term unemployment.
One area of hope for job creation is tourism. Mainland visitors, once a rarity, are arriving in ever-increasing numbers to sample the territory's capitalist lifestyle and to buy expensive goods. In July 2002, visitor arrivals jumped 16.5 per cent year-on-year to just under 1.4m – the highest July total on record and second only to the record month of April 2002. Mainland visitors comprised about a third of the July total, up 41 per cent compared with a year earlier.
The government hopes that a joint venture with Walt Disney to build a US$2.9bn theme park, to open in 2005/06, will further boost mainland visitor arrivals. However, it has emerged that Shanghai is in talks with Disney about building a rival park, a development that could upstage the Hong Kong project.
The territory's stock exchange remains Asia's second largest market open to foreign investors after Tokyo, but it has suffered heavily from the collapse in global equity prices. At the end of June 2002, its total capitalisation had fallen 15 per cent from a year earlier, to HK$4,400bn. There were 34 new issues on the main board in the first half of 2002, raising a total of HK$17.4bn (US$2.2bn), compared with HK$59bn for 31 new issues in the whole of 2001. Perceptions of weak corporate governance have increasingly become an issue. The government is studying a proposal to transfer responsibility for supervising listings from the stock exchange to the official regulator, the Securities and Futures Commission.
However, the stock market remains an important channel for the mainland's flagship state-owned enterprises to raise international capital. In July 2002, the Hong Kong operation of Bank of China, one of the mainland's 'big four' banks, raised US$2.8bn on international markets, much of it in Hong Kong. China Telecom, the fixedline telecoms carrier for the southern part of the mainland, has also been preparing to raise up to US$4bn on the market. The total sums being raised were a long way from the heyday of 2000, when Chinese companies reaped US$44bn from international markets. However, the trend is encouraging for Hong Kong, particularly the willingness of Chinese companies to stage listings despite difficult market conditions.
Soaring budget deficit
Hong Kong's budget deficit has been overshooting government targets, prompting concerns that the pegged exchange rate could come under threat in the longer term. In the wake of the Asian financial crisis, the government sought to pump-prime the economy by keeping taxes on hold while running a deficit. In 2001/02, however, the deficit soared to HK$63.3bn (equivalent to about 5 per cent of GDP), from an original target of about HK$3bn. The government forecast a deficit of HK$45.2bn for 2002/03, but it had already reached HK$56bn in the first five months of the financial year.
The rising deficit contributed to jitters in the money markets in 2002 and helped to fuel rumours that the government was reconsidering the peg. Few people, however, believe that action is imminent on the exchange rate. The government still has one of the strongest financial positions in the world, with fiscal reserves of HK$316.5bn at the end of August 2002, albeit down from HK$332.4bn a month earlier. Much will depend on whether financial secretary Antony Leung can meet his promise of restoring the budget to balance by 2006/2007, through civil service pay cuts and other measures.
Beijing has continued to be largely successful in honouring its pledge to maintain the 'one country, two systems' model under which Hong Kong has significant autonomy to run its own affairs. Since the handover from Britain in 1997, Chinese officials have for the most part been careful not to interfere in matters outside the scope of defence or foreign affairs, the two areas in which the Hong Kong government is obliged to defer to Beijing.
There has been much criticism, however, of the territory's awkward political system and of its chief executive, Tung Chee-hwa. A former shipping tycoon, Tung was handpicked by Beijing to lead Hong Kong after the handover. He began a second five-year term in July 2002, after being re-elected unopposed by an 800-strong election committee consisting mostly of conservative businessmen. A poll carried out by the Hong Kong Transition Project at the Hong Kong Baptist University in August 2002 found that 39 per cent of people were 'somewhat dissatisfied' with Tung's performance and 28 per cent were 'very dissatisfied'.
Overhaul of political system
Tung marked the beginning of his second term by launching the biggest overhaul of the territory's political system since the handover. In a move he said was aimed at improving accountability, he appointed 14 new cabinet officials, or 'ministers', a departure from the former colonial-based system under which all top officials were civil servants. The government argues that the new political appointees are more accountable because, unlike civil servants, they can be fired if their performance is not up to scratch. Critics of the system say that without proper elections, the officials are accountable only to Tung.
Another area of controversy involves creeping new restrictions on human rights and freedom of speech. The government has begun a consultation period on its plans for a controversial anti-subversion law, which prodemocracy groups worry could be used to curb fundamental rights such as freedom of speech and association. The government is required to implement the legislation as part of Article 23 of the Basic Law, the mini-constitution that defines the territory's autonomy. The government insists the law will not impinge on Hong Kong's freedoms. But prodemocracy groups argue it will leave the local government vulnerable to pressure from Beijing to ban groups that are illegal on the mainland. They are also concerned it could be used to curb freedom of the press.
Such issues aside, Hong Kong remains a cosmopolitan and open society. The government's stated aim is that the territory should become Asia's leading world city. Of a total population of nearly 7m, around 7 per cent are expatriates or overseas domestic helpers.
Hong Kong has retained its strong legal system and regard for the rule of law, and it remains one of the easiest places in Asia in which to do business. It is ranked the eighth largest trading entity in the world and Chek Lap Kok is one of the world's largest and most impressive airports. Passengers can expect to wait no longer than 10 minutes after arrival to retrieve their luggage, before being whisked away by an ultra-modern train for the 20-minute ride to Central.
The territory's economy is predominantly driven by services, with this sector accounting for 85 per cent of its GDP and four out of every five jobs. The contribution of manufacturing to GDP has declined, from 24 per cent in 1980 to about 7 per cent today. Over the past two decades, nearly all production facilities have moved across the border into southern China, where Hong Kong companies now employ 5m people.
The city has the highest concentration of regional corporate headquarters in Asia. According to a government survey, 3,237 overseas companies had regional operations in Hong Kong as of June 2001, up 7.9 per cent from the previous year. This was a record high since the survey started 11 years previously. Of these regional operations, 944 were identified as regional headquarters and 2,293 as regional offices. Of the 944 regional headquarters, 221 were for US-based companies, 160 were Japanese and 90 from the UK, with the remainder coming mostly from Europe or Asia. Most companies consider Hong Kong's clean government and rule of law as among the most important reasons they chose to set up in the territory.
Hong Kong's major export markets are the Chinese mainland, which accounted for 37 per cent of total exports in 2001, followed by the US with 22 per cent and the EU with 14 per cent. Since 1980, exports to the Asia- Pacific region as a whole have been growing rapidly, as a result of import liberalisation in many of these countries.
Hong Kong's big commercial and trading advantage remains the huge hinterland of China. The SAR is by far the largest source of external direct investment in the mainland. At the end of 2001, some 51 per cent of the 389,549 overseas-funded projects registered in the Chinese mainland were Hong Kongrelated. Contracted and utilised capital inflow from Hong Kong amounted to US$349bn and US$187bn respectively, each accounting for 47 per cent of the national total.