(Reprinted from HKCER Letters, No.40, September 1996)


Economic Integration of Hong Kong
and Southern China

William Fung


On March 27, 1996, the Centre hosted a private talk with local economists. The audience had the pleasure of listening to guest speaker Mr. William Fung discuss the topic of the economic integration of Hong Kong and southern China. Mr. Fung is managing director of Li and Fung Co. Ltd., and President of the General Chamber of Commerce. The following is an edited version of his speech text.

I would like to talk with you about some ideas currently held by the Hong Kong business community regarding the integration of Hong Kong and China. For the last 150 years, Hong Kong has served as China's entrepot, with the important exception of the 30 years from 1949 to 1979. During the latter period, we accumulated money and human capital, partly due to the influx into Hong Kong of resourceful refugees from China in 1949. Because Hong Kong is such a small market, we were forced to export. We developed skills primarily in the area of what I would call labor-intensive production of consumer goods. I maintain that this remains the unique skill base of Hong Kong. The skills we learned from servicing that sector enabled Hong Kong to develop its service industries: financial, legal, accounting, and so on.

When China opened up in 1979, it was with one purpose: to use its only comparative advantage in order to earn the foreign exchange needed for upgrading its infrastructure and improving the lifestyles of the Chinese people. China's comparative advantage at that time was of course its labor pool. There are different ways to access the labor pool. One is the method employed by the Philippines of exporting people around the world to serve in different economies. China chose, instead, to open up enclaves in which labor-intensive manufacturing could be set up to produce consumer goods. These goods were to be exported in order to earn the foreign exchange China needed.

I maintain that since the country opened up, this type of manufacturing has been the primary focus of the policies of the Chinese government. The Chinese government talks about taking other steps, such as opening up domestic markets, but it has not done much about putting these ideas into practice. As of today, the wholesale, retail and most of the service markets are still closed.

Regarding the opening of China in 1979, I would first like to stress that it came at just the right time for Hong Kong. If China had opened 20 years earlier, Hong Kong would not have been ready to take advantage of the situation. If China had opened 10 or 20 years later, we would already have lost some of the skills necessary for the labor-intensive production of consumer goods.

It is also important to point out that even prior to China opening up, Hong Kong was already beginning to market its skills abroad in countries such as Singapore. However, for a company to go abroad to places other than China required that it be somewhat multinational. It meant that employees must perform in a different language and in an unfamiliar cultural environment. Prior to 1979, the majority of Hong Kong companies did not have personnel to meet such challenges. In contrast, the opening up of China allowed small and medium-sized Hong Kong companies to enter southern China, where the technology those firms possessed could be used much more effectively. China was the only place that offered the right environment at the right time to maximize the managerial talent offered by our small and medium-sized companies. Not just one or two companies, but rather the bulk of Hong Kong industry was able to move into southern China. Also, China offered Hong Kong businesses many advantages over other less developed countries (LDCs). China's proximity to Hong Kong was an advantage. After China opened, the front and the back ends of factory operations remained in Hong Kong, but the intermediate labor-intensive segment relocated to China. This would have been much more difficult to engineer if China were farther away from Hong Kong.

In addition to allowing factories into the country, China had other policies which benefitted Hong Kong. One of the most important of these was the fact that China allowed labor to move quite freely between provinces. Hong Kong companies were not restricted to using only the local labor pool, which was important because we absorbed that labor so quickly that we were soon bidding up the wage rate in the Pearl River Delta. Had it not been for China's policy of allowing labor from other provinces into the area, the upward pressure on wages would have slowed the momentum of developing industries in southern China.

In consumer goods markets, it is becoming increasingly important to be able to respond quickly. In the past, when we sent labor-intensive consumer goods to places such as the United States and Europe, the major factor affecting our exports was the price. Orders were placed six to nine months ahead of time, and if the product did not sell well, it had either to be discounted or simply destroyed. However, in the last 10 years, managers have begun to realize that the biggest cost of running a store is not the cost of the product itself, but the expense of obsolete inventory. Now we aim for quick response, meaning that we try to compress the production lead time as much as possible. The Hong Kong-South China combination is highly conducive to a quick response. The cost of setting up shops in southern China as compared to relocating to the hinterland is somewhat higher. Still, for most companies, the lower costs are insufficient to induce them to move to China's hinterland, where response time would be slower.

What will happen after 1997? My stock answer to this question is that for the Hong Kong business community, the important date is not 1997, but 1979. That was when Hong Kong's economy began integrating with that of southern China; 1997 is really more of a political date. In the future, though, I think that Hong Kong will continue to enjoy a comparative advantage in managing and putting together export programs for labor-intensive consumer products made in China.

There are some problems, however, with the Hong Kong-China relationship. First, because Hong Kong companies are now so much larger, more of them could go overseas and be multinationals. So Beijing cannot count on Hong Kong industrialists staying in China if conditions there are not favorable or if costs there escalate. Also, there is a great deal more competition out there for this type of investment in labor-intensive industry. While many governments are only looking for high-technology investments, some, e.g., Vietnam, are still interested in labor-intensive industries with low-technology barriers. A simple reason for this interest is the time factor. I can talk to a Hong Kong investor about a shoe or garment factory, for example, and the factory could be in operation six months later. I could talk to a Japanese investor about a car factory and it would take five years to negotiate a deal. Five years is a long time to wait.

Another factor which could cause China to lose the industrial base built up by Hong Kong investors in southern China is the unfavorable opinion towards goods made in China. It is said that China will be the next economic superpower, and inevitably there will be China-bashing. I think that the protectionist measures expected to be levied against China by our major markets (America and Europe) will get stricter, not more lenient. This protectionism is hard to fight because it has moved away from tariff barriers to nontariff barriers. I think China has been subjected to more pressure regarding the issues of copyrights and human rights than has any other LDC. This will likely continue. If we are not stopped by protectionist measures, I think Hong Kong and Chinese companies will eventually dominate the world supply of low-technology consumer products.

Balanced against the above-mentioned reasons for Hong Kong investors to move out of China is an important reason to stay: Domestic markets in China will eventually open up. This is happening already, albeit slowly. Consumers in China are now saying, "If I cannot get imported goods, at least I want goods of a quality comparable to our exports." As you may know, any export company in China with a local partner is allowed to sell a certain percentage of its products on the domestic market. Such demand for high-quality goods could become huge.

In the meantime, what is happening to Hong Kong? We must remember that Hong Kong is not a self-contained economy. It is a city economy, such as that of New York or London, that is able to service a bigger economy such as southern China's. When most people envision a service economy, they think about things that cater to the consumer, such as flipping hamburgers. I see Hong Kong as a service economy that provides services to the production industry. I am talking about professional services to businesses and to manufacturing outside Hong Kong -- to transportation; shipping; financial, legal, and accounting services; design; marketing; quality control; and so on. I see Hong Kong as an economy that services other people. We are servicing the China market, the regional market, and eventually we may service the world market.


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