(Reprinted from HKCER Letters, Vol. 22, September 1993) 


Hong Kong as Telecom Entrepot?
Hong Kong's International Telecommunications Policy and Regional Integration

Milton Mueller


At a social gathering in the U.S. recently, I encountered a man who symbolizes what could be the future of telecommunications in the greater China region. No, it was not some technological genius with a remarkable new service or system. Neither was it a pinstriped, business-school-bred financier ready to pour millions of dollars of capital into some promising new venture. It was a small and rather grubby Chinese trader. He and his brother owned a Hong Kong-based firm which imports drinks into Hong Kong and then re-exports them from Hong Kong to China. The man was proudly explaining to me how setting up a dummy corporation in Hong Kong and falsifying customs documents saved him hundreds of thousands of dollars in profits.

This exposition of Hong Kong's classical role as intermediary and entrepot took on a new twist, however, when he added that he had been approached by someone in Beijing who wanted him to invest in a mobile telephone service in the city. If he, the Hong Kong trader, could supply the capital investment for the equipment and technology, his Chinese partner would operate it and sell telephone numbers to customers. Both would reap enormous profits by supplying the drastically undersupplied market for telephone service in the city. Who, I inquired, was this would-be joint venture partner and how did he acquire license rights to use the radio frequency spectrum? The Hong Kong trader's answers were vague. It was not the national Ministry of Posts and Telecommunications (MPT), but it was not clear whether his partner was part of the local telephone company, or some other institution in China with spectrum usage rights.

It became apparent that in China, as in other economies making the transition from socialism to capitalism, a form of spontaneous privatization was taking effect. Resources and rights with no clear lines of ownership were being sold or appropriated by quasi-entrepreneurs based in state posts.

The process of spontaneous privatization in China's underdeveloped telecom sector, and the potential role of Hong Kong traders in advancing it, is significant because it gives us one model for conceptualizing future relations between Hong Kong and China after 1997. Economists have shown how Hong Kong's intermediary role in commodity and financial services trade has made economic reform in China successful. Ironically, China's opening to the outside world increased rather than decreased the need for a middleman. Hong Kong, with its capitalist economy and bilingual culture, was ideally suited to the role of intermediary.

The question I want to pose here is, can the same kind of relationship develop in the telecom sector? That is, can Hong Kong, with its increasingly liberal telecom structure, become the focal point of liberalization of telecom services within China, just as it has become the key to economic reform in commodity trade, manufacturing, and financial services? My answer is that it is possible for such a relationship to develop, and that it would be beneficial to both parties. This goal faces strong political obstacles, however. Hong Kong's trade and telecommunication policy makers need to develop a strategy for overcoming these obstacles. In order to do this, Hong Kong must become officially involved in the internal PRC discussions over the future of reform in the telecom sector. It must also wake up to the fact that the success of its move toward liberalization and competition in its domestic industry hinges upon reciprocal moves toward reform in China.

The 1997 Conundrum

There are important similarities between the telecommunications sector and the other areas of the Chinese economy which have been opened to economic reforms. In both cases, Hong Kong has capital as well as experience with the most advanced technologies, which is precisely what China lacks. The most critical difference is that the PRC has not, as yet, made a decision to "reform" its telecom sector along market-economy lines. Posts and telecom hold special status as a sector which should be exempted from market forces. The Chinese MPT lobbies strongly for maintaining this special status. It is attempting to develop and maintain a traditional national PTT (Post, Telephone, Telegraph) monopoly. The natural tendency of Hong Kong to become a telecommunications entrepot thus faces a very large obstacle.

Part of the problem is economic: MPT fears that the entrance of highly mobile and competitive Western or Hong Kong-based firms would siphon away revenues it needs to develop the country's infrastructure. But the MPT resistance to foreign involvement goes deeper than that. PRC policy is currently to keep foreigners out of the ownership and management of any part of the telecommunications infrastructure. They claim that the issue is nothing less than one of political sovereignty. Drawing on China's sorry past history of incursions by foreign powers, the defenders of MPT monopoly claim that opening up the basic telecom infrastructure to foreigners would threaten the basic political order.

There is an important problem with the latter argument, however. After 1997, Hong Kong can no longer be considered a "foreign" territory. Aside from being predominantly Chinese ethnically, it will be under Chinese sovereignty. If the 1997 transfer does not totally undercut the sovereignty argument, it certainly complicates it. For while Hong Kong can no longer be classified as "foreign" after 1997, neither can it be unambiguously classified as part of the Chinese national telecommunications system. Hong Kong's telecom sector obviously cannot be treated like a provincial branch of the MPT. It has its own autonomous telecommunications administration (Hong Kong Telecom), which is majority foreign-owned. Hong Kong also has its own regime of law and regulation which is very much at odds with China's. This regime is quite pluralistic, featuring a growing number of IVAN operators, resellers, private networks, and, after 1995, local fixed networks. The regime not only allows but encourages foreign ownership of, and investment in, its industry. In short, after 1997 Hong Kong is neither fish nor fowl, not quite foreign but not quite domestic.

What form, therefore, will the new order take in the telecom sector? I can conceive of two basic models for structuring this relationship.

The first model is what I call "quarantine." By "quarantine" I mean that China will maintain the separateness of the two systems by treating Hong Kong like a foreign country in all but name. Hong Kong's telecom industry will transact with the MPT just as a foreign country does, paying accounting rates, etc.; Hong Kong investors, like other "foreigners," will face severe restrictions on their activities in China designed to shelter the MPT monopoly. Effectively, China simply assumes the role formerly held by the British, and treats Hong Kong as a semi-autonomous colony.

Another possibility is "integration." The integration model attempts to capitalize on the 1997 transfer rather than minimize its effects. It would use the 1997 sovereignty transfer to erode investment and operational barriers between Hong Kong and China. Consequently Hong Kong, with its dramatically more liberal regime, would become the telecom entrepot of the burgeoning trade in the greater China region. The integration of the telecom sector will require steps toward market reform of the PRC-side telecom sector. It will accelerate the liberalization process within Hongkong Telecom as well.

Why Active Integration is Best

Of these two possibilities, I believe that "integration" is in the best interests of both China and Hong Kong. The political influence of MPT and certain other factors, however, make "quarantine" the most likely path unless Hong Kong actively pursues other possibilities. Inertia is on the side of "quarantine" arrangements -- quarantine is the underlying model of the Joint Declaration and requires the least change in existing arrangements. It is also in MPT's perceived self-interest. Quarantine would, however, guarantee the continued underdevelopment of the PRC telecommunications sector for at least the next ten years, and would hinder, if not totally undermine, the progress of liberalization on the Hong Kong side. If integration is to take place, it will take active efforts from the Hong Kong side.

Integration is the best option for three reasons. First, integration of the telecom sectors would reinforce Hong Kong's competitive advantage as a regional economic hub. The report Hong Kong 21 by the Business and Professionals Federation claimed that "If Hong Kong has one unassailable and sustainable competitive advantage, it is its special relationship with South China" (p. 32). If Hong Kong-based businesses were able to participate in the development of China's telecom infrastructure, and if large corporate users of telecom services could avail themselves of more liberal arrangements that spanned the Hong Kong-China border, this special relationship would be enhanced.

Second, telecom infrastructure development on the Chinese side is the major factor driving telecom sector growth in Hong Kong. In the five years from 1986 to 1991, China's share in HKTI's international traffic doubled, from 18 to 36 percent. By 1994 China and Taiwan alone will account for more than half of Hongkong's international telecom traffic.

The dramatic influence of PRC telecom infrastructure development on Hong Kong can be seen from the change in the balance of IDD traffic from 1981 to 1991. From 1981 to 1990, more traffic came into Hong Kong from China than vice versa. The balance has been progressively changing, however, as China has developed a more extensive telephone system. Previously, China's underdeveloped infrastructure acted as a barrier to calls generated in Hong Kong. For parties to connect, the call had to come from public stations in China. As Chinese infrastructure developed, more outgoing calls from Hong Kong could reach their desired parties, and the balance shifted.

These changes have two important implications. First, high rates of growth in Hong Kong-China traffic will continue for some time. Telephone penetration in China is still low by developed country standards. It is likely that a great deal of potential telecom calls and data transfers are not taking place because of infrastructure limitations on the Chinese side. Second, the balance of traffic will continue to worsen, from the Hong Kong perspective. The outgoing traffic surplus means large settlement payouts from Hong Kong to China. This might be perceived as being in MPT's interest in a narrow and short-term way because of its ability to generate foreign exchange and higher revenues. It is definitely not in Hong Kong's interests, however, because it keeps IDD rates on China routes unnecessarily high, thereby restricting traffic flows. After 1997, as Hong Kong becomes more integrated into the South China economy, Hong Kong and China need to reduce if not eliminate accounting rates on their traffic.

Third, Hong Kong's attempts to promote competition in its own telecom sector will be undermined unless monopoly arrangements on the PRC side are relaxed. Recently Hong Kong altered its rules for international telecom in ways that promote liberalization and competition without violating the license of the Hong Kong Telecommunications International (HKTI). Much of the progress has been made in the area of resale and private networking arrangements, where competition and alternatives are not specifically prohibited by the exclusive license. The Office of the Telecommunications Authority is currently engaged in a thorough review of the international license in order to clarify the boundaries of exclusivity. It seems clear that Hong Kong's policy makers are willing to adopt as liberal an interpretation as is legally possible. Within such an environment, entrepreneurs and technical innovators can find ways to offer new services which undercut or bypass monopolistic arrangements. City Telecom is the most notable example of this kind of entrepreneurial activity.

This kind of innovation and entrepreneurship is possible, however, only when there are also liberal arrangements on the foreign side of the circuit. City Telecom, for example, was built not only on Hong Kong's relatively liberal arrangements, but also on the fact that Canada, the U.S., and Australia permit resale and overseas 800 services. When the foreign side of the circuit is a restrictive and protected monopoly, liberalization in Hong Kong will have little effect on monopolistic arrangements. Of course, China falls within this category. What makes this most unfortunate for Hong Kong is that China, as noted previously, accounts for close to half of its telecom traffic, and the proportion is growing.

Hong Kong has already had a demonstration of how monopolistic arrangements in China translate into monopoly in Hong Kong. The recent agreement by HKTI to reduce IDD rates gave Hongkong Telecom (HKT) the power to discriminate by route in its rate reductions. Naturally enough, HKT is reducing rates on routes where it faces resale competition -- basically to Canada, the U.S., and Europe -- and is leaving rates alone where competition is not possible. HKT claims that high accounting rates justify this discrimination. This may or may not be true, but the fact remains that accounting rates are being lowered to North America and Europe because of competitive forces. Where competitive forces are absent, as in China, accounting rates will remain high.

In short, Hong Kong has a direct and immediate interest in encouraging the reform of China's telecom sector along competitive marketplace lines.

The Problem of Hongkong Telecom's Ownership

One of the pivotal issues in the 1997 transfer is the ownership status of HKT. We must at least raise the question whether the PRC will exert pressure on Hong Kong to bring the situation here more into line with Chinese concerns about foreign ownership. By this I do not mean that the PRC will try to reverse recent moves toward pluralism and deregulation in the local marketplace. There is no evidence to indicate that the PRC would try this, and even if it did, it probably could not succeed. The main issue, rather, is the ownership of HKT. HKT's status as a predominantly British-owned corporation not only conflicts with the PRC's concerns about foreign involvement in infrastructure, but it also makes moves toward market integration after 1997 more problematical for the PRC. An HKT which was majority-owned by local and/or PRC shareholders would make it much easier to move toward full market integration. With or without market integration, it is possible that the PRC's opposition to foreign control of infrastructure will compel it to move in some way to reduce or eliminate foreign ownership of HKT.

Needless to say, this is a difficult and sensitive issue. HKT is the crown jewel of Cable and Wireless's global holdings and it might not be willing or able to relinquish it. Nor should Hong Kong be willing to accede to pressure to back away from its general policy of encouraging a business climate that is open to foreign investment.

What Hong Kong Should Do

In conclusion, I would like to offer the following guidelines for Hong Kong in approaching the 1997 transfer.

First, Hong Kong must develop ties to the major interests in the PRC telecom sector other than the MPT, specifically large users and other ministries. Attempting to convince the MPT to relinquish its monopoly control of the sector makes as much sense as attempting to convince the Communist Party to give up its monopoly on political power. Monopolies are broken or relaxed by external pressure, not by persuading the monopolist. Hong Kong should therefore participate in the internal discussion now going on within the PRC concerning the nature of the telecom sector.

Second, Hong Kong should argue against quarantine of its telecom sector and for some kind of special status within China after 1997. Its industry and government can argue with great legitimacy that after 1997 it should no longer be placed in the same class as "foreigners" and that the PRC sector can be opened to Hong Kong involvement without committing the country to rampant and indiscriminate foreign involvement. One possibility, for example, is to jointly develop a mutually acceptable B-O-T arrangement with provincial and national MPTs.

Third, if the second objective requires an ownership change in HKT as a quid pro quo, then ways of achieving this without harming the legitimate interests of Cable and Wireless and without damaging Hong Kong's open economy should be explored.

Finally, Hong Kong should lobby for reduced accounting rates with China. In order to increase HKT's incentive to pursue this goal, it should require that the 8%-2%-2% IDD rate decreases be extended to China traffic.

Dr. Milton Mueller currently teaches in the Department of Communication at Rutgers University, U.S.A. His monograph International Telecommunications in Hong Kong: The Case for Liberalization, published as an HKCER paperback, won the Sir Antony Fisher International Memorial Awards in 1992. The above article was presented in the Conference on Telecommunications and the Integration of China sponsored by HKCER.


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