The magic is back

Hong Kong can really pour it on. Red-skirted tourist board greeters, all wearing Kodak-moment smiles, meet travelers being decanted from just-arrived planes at the airport with bags of maps and discount coupons.

There are candies at the immigration counter – or would have been if that bratty little kid in front hadn't pocketed the bottom half of the bowl when the inspector was distracted by that patch of gum stuck to his ID card.

Hong Kong is big on the thoughtful little touches, like the sign at the Airport Express train station inviting travelers feeling ill to call for an attendant. Indeed, the signs are everywhere that you have landed not at Kennedy, Heathrow or some other hub from hell, but at the brightly polished front door of the world's most efficient city – and one of the planet's friendliest.

Cantonese people seem to have friendliness in the blood and a natural ease with strangers, traits made indelible from centuries of trading. They don't go brittle if a visitor trips up with his chopsticks or absentmindedly slips the business card just handed him into his pocket instead of respectfully studying it, as convention rules. They can tweak the rules if they need tweaking and some time can be saved.

It is hard to imagine a people easier to get REGIONAL FOCUS/ HONG KONG Peak view: Looking over Central and beyond to Kowloon and beyond that along with, or to do business with. And how fitting, since services are what this town is nearly all about these days – having transitioned from being world-beaters in toys, garments, watches, electronics and other manufactures.

Shift to services
Fred Lam, executive director of the Hong Kong Trade Development Council, watched it all happen. "This shift is seen very clearly in the percentage of Hong Kong's GDP in services – about 88% in 2004 as against 67% in 1980 – making us the most service-orientated city in the world," he explains.

But even talking as he does, Lam refuses to let go of Hong Kong's ties to manufacturing. "We continue to be a major manufacturer and exporter (albeit using production facilities in the Chinese mainland)," he says. "In many instances, traditional toy manufacturers, for example, have now moved up the value chain and are classified as import/export service providers."

If distinctions between Hong Kong and neighboring Guangdong are fuzzy, and perhaps arguable, one fact is indisputable: Hong Kong investors kick-started China's boomingest province, and biggest exporter, and Hong Kong still owns most of the industrial plant that keeps China's export machine pumping.

Lam remembers how the shift from pure manufacturing towards services started in earnest 25 years ago – when Special Economic Zones were opened in Shenzhen across the line from Hong Kong and Zhuhai, just a traffic light from Macau. "This gradual opening of the mainland to the outside world, and in particular to Hong Kong, created an opportunity that Hong Kong companies were quick to seize."

For the first time, tiny Hong Kong could claim a large domestic market, he says. "That was something we never had – hence our reliance on external trade. While some talk about Hong Kong no longer being the unique gateway to China, the reality is that the more China opens up the more opportunities there are for Hong Kong," he says. "As China continues to develop, the market for Hong Kong products – especially Hong Kong-designed products, which, second to European products, rate as the most stylish/ highest quality in China – continues to grow."

Lam is happy to walk you through some telling data. "If you look at the numbers, for example, in 1979 (when China first opened to outside business), Hong Kong trade with China accounted for 4% of Hong Kong's external trade.

"Fast forward to 2004, and it now accounts for almost a third of our trade," he says. And over the same period Hong Kong has risen from being the 23rd largest trading region in the world, to the 11th – not bad for a population of fewer than 7m! And this trend is set to continue."

One man who isn't shy about talking up Hong Kong's splendors is Mike Rowse, director general of the city's investment promotion arm, Invest HK. "We identified nine priority sectors on which to focus our efforts," Rowse says. The list: financial services, information technology, technology (especially electronic sand biotechnology), telecommunications, media and multimedia, tourism and entertainment, trade-related services (including retail and sourcing/procurement services), business and professional services and transportation.

Leading road shows across Europe, North America and Asia, Rowse and his colleagues managed to draw investment commitments from 205 companies in 2004 – 29% of that number from Europe, 29% from Asia-Pacific (including Australia and Japan), and 23% from North America.

The Asiapac number, in fact, is larger than it appears, because mainland companies (35, constituting 17% of the 2004 total) are listed separately. These firms did not wander across the border on their own. Touting Hong Kong as the perfect place to establish bases for reaching out to global markets, Rowse's department arranged over a score of investment seminars in cities across the mainland in 2004, and held as many meetings on the Hong Kong side of the border with groups visiting from the mainland to size up the opportunities.

"In response to the growing interest and investment from mainland enterprises, the department has reinforced and expanded the investment promotion teams focusing on mainland-related projects," Rowse says. "Now, there are five investment promotion teams, including the team situated in Guangzhou."

Invest HK also launched its "One-stop Service" last year, specially targeting mainland investors and providing what Rowse describes as "free, tailored investment facilitation services". Mainland companies now account for about 20% of the department's active projects.

The TDC's Lam senses the shift, too. "Hong Kong has for the past 25 years been a major investor in the Chinese mainland – almost 50% of China's total foreign direct investment (FDI) comes from, or through, Hong Kong – but what we're now seeing is a lot of money flowing the other way," he says. "Hong Kong has emerged as a major fund-raiser and wealth management center for the mainland's new ambitious enterprises and ambitious individuals."

Mainland companies have certainly shown a decided preference for Hong Kong's stock markets over their corpse-like counterparts across the border. Chinese-related stocks (H shares and red chips) now make up half the stocks listed on the HKSE, and on average, half of every trading day's turnover is in H and red shares. Or put another way, equity raised by mainland-linked companies in Hong Kong added up to US$24.8bn at yearend 2004.

Helping manufacturing
"The only thing likely to slow China's booming manufacturing sector is a lack of sophistication in the service sector," Lam says. "This need for modern, reliable, high quality business services (logistics, supply chain, financial, legal, sales, marketing, customer-care) is music to Hong Kong's ears, where we have an abundance of these kinds of services."

All these trends were well under way by the time the concept of the Pan-PRD (Pearl River Delta) slipped into the lexicon. With Beijing's blessing, the idea called for China's southern provinces, from Yunnan on the Vietnam border to Fujian across from Taiwan, to huddle around Hong Kong and work towards developing as an integrated economic region. "While the role of the new developments among southern China provinces (or Pan-PRD+2) is still untested," Lam says, "we firmly believe that this is a strong move in the right direction.

The region would sweep up some of China's poorest provinces, and any activity that would stir up investment in the country's vast have-not zones is a good thing from Beijing's standpoint. Central government per capita GDP figures for 2004, for example, show income plummeting from Guangdong's high of RMB16,990 per head to Guizhou's low of RMB3,601.

All in, the Pan-PRD has a population of around 457 million, roughly the size of the enlarged EU, and has a GDP of about US$634bn – one province, Guangdong, accounting for US$193.47bn of that. Comparisons with the European Union can be a trifle illusory, though – EU GDP topped .10trn in 2003 (nearly US$13trn translated into today's dumpy dollars).

The region also draws about half of China's inward FDI, and accounts for 43% of total exports – the overwhelming proportion generated by Guangdong, followed by Fujian province.

Lam, busy preparing for an assault on Eastern Europe when CHINA ECONOMIC REVIEW came calling, is bullish about the possibilities. "Currently Hong Kong is the international service centre for the Pearl River Delta region – and this enlarged hinterland makes it easier to serve more companies across this southern region."

But how about Hong Kong's land and labor costs, which are sky-high compared to those on the mainland? Rowse jumps right into the debate, quoting a survey – "Report on 2004 Annual Survey of Regional Offices Representing Overseas Companies in Hong Kong" – released by Hong Kong's Census and Statistics Department. "It includes a survey on the importance of factors affecting the choice of location for setting up regional headquarters/ regional offices," he says, explaining the poll measures 25 factors altogether.

"Investors found the free flow of information, low and simple tax system, corruption-free government and absence of exchange controls the most important factors in their investment decisions. The "cost, availability and productivity of staff" ranks 15th in terms of importance, the "cost and availability of business accommodation" ranks 22nd and the "cost and availability of residential accommodation" ranks 25th as the least important factor."

"Cost is a relative thing. It is natural for investors to place their labor-intensive manufacturing function in the mainland or other places in the region for cost reasons, and put functions requiring skilled labor and sophisticated services – such as sales and marketing, Trams still rattle and roll logistics, accounting, management and trading – in Hong Kong."

Rowse also throws in the old rule-of-law argument for setting up in Hong Kong. "We also have noticed a trend among foreign businesses – especially those involved in hightech, design and brands – setting up their international intellectual property centres in Hong Kong due to the strong intellectual property protection."

Ups and downs
Hong Kong, like any economy, has had its up and downs, although the mid-1980s boom went so far into the next decade that locals got a notion they were on a permanent high. The city, thanks to a government working hand-in-hand with the developers, was also lining itself up for a property bubble that Hong Kong is only now recovering from.

Where small investors could once buy flats almost entirely on bank loans and park tenants in them to cover the mortgage – if these owner-speculators weren't constantly trading up to more luxurious properties – condominium apartments suddenly turned from being get-rich-quick no-brainers to negative assets; many investors found themselves stuck not with not just one flat, but often several – with multiple mortgages to pay as their tenants were washed overboard in the sinking economy.

The 1997-98 currency crisis had arrived, hammering South Korea, crushing Indonesia and laying low other economies across Southeast Asia.

Lam watched the recovery slowly take hold. "I think there are a number of interrelated factors that have lifted the mood in Hong Kong," he says. "The Asian economic flu forced all Hong Kong companies to take a closer look at their business models. "We saw a lot of consolidation, streamlining and efficiency drives. We're now starting to feel the benefit of having leaner, meaner companies!" he says.

China, thank goodness, stood rock steady through the regional crisis, keeping its yuan firmly pegged to US dollar. It was the other system in Deng Xiaoping's "one country-two system" formula for absorbing Hong Kong back into China, and that deal called for Hong Kong keeping on its capitalist course unfettered for 50 years till 2047.

In a sense, Hong Kong had put up a fence of exclusivity, but any sense of self-importance did not last long. Now that the chips were down, it wanted easier access to mainland opportunities and maybe special treatment relative to China's other trade partners. It got it in the form of CEPA – the Closer Economic Partnership Agreement – which accorded special advantages to Hong Kong-based service and manufacturing companies seeking to do business in China.

Lam thinks CEPA has been especially good for the services side. "CEPA has opened up China to Hong Kong service providers in the same way that the SEZs opened up China to Hong Kong manufacturers." China helped lift Hong Kong's economy in other ways. Its new Individual Visit Scheme made travel to Hong Kong easy. The new rules waived old restrictions requiring mainlanders, other than students and business executives, to travel only in tour groups. "This has had a major impact on our domestic economy," Lam says, listing hotels, restaurants and shops as being prime beneficiaries. In 2004, 12m mainland visitors flooded into Hong Kong, help driving Hong Kong's total visitor count up by a third over 2002 levels. (The devastating SARS crisis in 2003 makes year-on-year comparisons meaningless: in Hong Kong's darkest hour, five-star hotels had near 0% occupancy rates.)

Even so, Lam makes a point that tends to get forgotten. "Even in 2003, with SARS, imports and exports still rose at double digit level.?

"And this year, we've seen that again. The strength of the euro has certainly made our products attractive in Europe, where we've seen particularly strong export growth, and similarly the improvement in the Japanese economy has prompted a pick-up in orders from the north," he says.

Hong Kong clearly turned a corner in 2004, Financial Secretary Henry Tang reporting 8.1% year-on-year GDP growth in his annual budget address in March – a spectacular turnaround given the city's calamitous last few years.

Another feature of the story Tang thought worth bearing in mind was that while Hong Kong had seen some spectacular boom years, it had actually averaged 4.8% growth over the last 20. He also said this year would mark the first time the government would record a surplus after years of operating deficits. "This suggests that our economy is back on an upward track following the adjustments over the past few years," Tang said.

The jig may be up on the old cross-border tax dodges like transfer pricing, allowing affiliates in low-tax Hong Kong to keep profits while their mainland subsidiaries "lose" money. But Hong Kong still make a reasonable claim to offering the best in a lot of areas – not least in transport infrastructure, the cheapest telecom services, and Internet access without page blocks that mainland Internet police throw up at every turn. It also has, as Rowse says, rule of law. Ooops, that's a sticky bit: Hong Kong lawyers are among the world's most expensive.