(Reprinted from HKCER Letters, Vol. 51, July 1998) 


Is Hong Kong Finished?

Li Hao and Wing Suen


This year, for the first time since 1985, Hong Kong registered a first-quarter negative growth rate. Despite government officials' repeated assurances of "sound fundamentals" the outlook for the economy's long-term future has become gloomy. Rent in Hong Kong is too high. Mediocre managers and administrators earn amazing salaries considering the amount or the importance of their work. Speculative fervor draws energy away from enterprise. Government mismanagement, real or imagined, nips at Hong Kong's free-market foundation.

Are these problems new or just newly discovered? Hong Kong's economic success has been nothing short of a miracle. One theory has it that we are just lucky. At every critical junction, events took the best possible course for Hong Kong.

The miracle was born when the communists took over China. The refugee workers and entrepreneurs that came here as a result helped turn Hong Kong into a successful manufacturer of textiles, toys, and electronics. When labor costs began to erode Hong Kong's competitive edge, China opened its doors to foreign investment. Hong Kong's investors and managers jumped at this opportunity and swarmed into South China. And just when Hong Kong managers became too expensive relative to the local supply of talent, the demand for financial services arising from mainland business needs exploded. Hong Kong quickly transformed itself into a world-class financial center.

But our luck is running out. Since Shanghai woke up a few years ago Hong Kong's status as the financier for Chinese economic development has been under threat. Steven Cheung of the University of Hong Kong often comments on the fact that Shanghai's college students study so much harder than do their counterparts in Hong Kong. They learn English; they understand stocks and derivatives; they can prove the Modigliani-Miller theorem. And they are willing to work for a fraction of the pay that Hong Kong graduates are getting. It is not hard to imagine that some day mainland and foreign investors will find it both cheaper and easier to engage in transactions in Shanghai than in Hong Kong. What will become of Hong Kong without the financial industry?

That Shanghai may gain ascendancy is a valid concern, but one should not lose sight of the comparative advantages of the Hong Kong economy. In Hong Kong there is an efficient legal framework, a working administrative system, a close connection to international financial markets, and a state-of-the-art infrastructure. Hong Kong has all the hardware, but how can it best exploit it? The answer is simple: by getting the best software.

It is well recognized that entrepreneurs from Shanghai played a crucial role in bringing about the industrialization of Hong Kong that took place in the 1950s. The supply of talent in Hong Kong at that time was rather limited. One would like to believe that as the city became more prosperous the situation changed. True, fifty years of economic development has improved the human capital stock of Hong Kong tremendously. Hong Kong may even claim to train better people than Shanghai does now (Steven Cheung would disagree). It is all too easy to turn complacent, however. As migration control in China relaxes, Shanghai has been drawing talent from all over the country. Hard as Hong Kong may try, it is tough to beat the numbers: the best and the brightest from a pool of 6 million people will face an uphill battle against the best and the brightest from a pool of 1.2 billion.

The problem of small numbers is compounded by the problem of thin markets. Workers in Hong Kong who have highly specialized skills do not enjoy all the protection offered by competition. For an air-traffic controller or a differential topologist who is not internationally mobile, alternative employment opportunities are few and far between. Employment risks in a thin market discourages investment in specific human capital. In response, Hong Kong workers choose breadth over depth. No wonder why they are more renowned for their flexibility than for their expertise.

If Hong Kong wishes to boost its human resources it cannot afford to rely exclusively on local talent. No investment is large enough to overcome the disadvantage inherent in small numbers and thin markets. That is why Hong Kong has been importing skilled labor from all corners of the world. Except from the mainland. True, many highly educated mainlanders are now working in Hong Kong, but most of them came by way of North America or Europe. It is a shame that America, not Hong Kong, gets some of the best brains in China. If Hong Kong opens up to skilled mainland labor, the combination of a high living standard and locational advantages will be irresistible to many mainlanders.

A practical way of attracting talent is to allow mainland (and overseas) students at local universities to stay in Hong Kong and find work after graduation. If the mainland government allows students to go to the United States, it will not object if they come to Hong Kong instead. So it is unlikely that tapping Chinese human resources will invite the mainland government's interference with local affairs. At present the University Grants Committee allocates only two percent of the undergraduate intake to nonlocal sources. Moreover, many mainland students with degrees from Hong Kong find it easier to go to the United States than to stay here. These students should be given the opportunity to become permanent residents in Hong Kong. The government could permit them to stay as long as they are able to keep jobs in the Hong Kong, which is effectively what the United States does to keep many of its former students there.

Studying at Hong Kong universities will then become appealing enough to attract the best mainland talent, and the intake quota should be raised. Because of the sheer size of its population, mainland China produces more innate talent than does Hong Kong. Yet education resources in Hong Kong are far superior to those in China. Bringing mainland talent into contact with the superior education resources will benefit the mainland students themselves, their teachers, and their fellow students in Hong Kong. When they leave the education system they will become part of the software that is key to Hong Kong's development.

The government should also import skilled labor directly from China. Talented mainlanders will bring with them not only skills but also the specific knowledge crucial for the success of China-related businesses. This specific knowledge complements Hong Kong's hardware advantages, but Hong Kong's education system is unlikely to impart it to local students. Mainland talent should be treated in the same way as is the talent of other countries. In particular, skilled and professional workers from the mainland should not be confined to working in mainland financed enterprises. They should be allowed to move freely between mainland China and Hong Kong. Mobility is crucial to making Hong Kong an attractive destination for talented mainlanders, because some of them perceive the mainland as having more opportunities than Hong Kong does right now. If mainlanders can move freely, then the labor market will sort out the right kind of workers for both Hong Kong and for the mainland.

A new labor-importation scheme may sound like heresy now that unemployment is at a fifteen-year high, but it is during times like this that we should be especially vigilant about the rise of protectionism. The current labor-importation schemes, which focuses on importing less skilled workers, are indeed perverse. Real wages for unskilled labor have remained relatively flat for several years, whereas wages for managerial and professional workers soared. Hong Kong's future lies in high value-added industries-sectors that will serve the business needs of China. It is brains, not brawn, that Hong Kong is short of. Bad economics will try to say that the importation of skilled labor will eliminate jobs for local Hong Kong people. But different types of human capital tend to complement one another, and they tend to complement raw labor power as well. An increase in the supply of skilled labor with specific human capital will raise, instead of reduce, the demand for other skilled labor and for unskilled labor as well.

Business cycles come and go. Concerns about present economic troubles should not delay plans for the long-term future of the economy. By the time the proposed policy is in place and mainland students have started looking for jobs upon graduation, Hong Kong's labor market may well be tight again. No government can fine-tune its policies to the employment situation three years down the road. Governments can only hope to adopt policies that are likely to contribute to long-term productivity growth.

So many people in Hong Kong worry about losing out to Shanghai, but few have asked just why China should build another financial center when Hong Kong can provide most of the services the country requires. After all, even the United States, which is a bigger economy than China is, has only one financial center - New York. Some say a separate financial development in Shanghai is justified because the renminbi is not convertible. But this should be the window of opportunity for Hong Kong, instead of an excuse for no action. If Hong Kong does not act, in ten years' time China's service providers will be in Shanghai, and those for the rest of Asia will either move east to Tokyo or west to Singapore. That would finish Hong Kong once and for all.

Li Hao and Wing Suen are lecturer and senior lecturer respectivley at the School of Economics and Finance, the University of Hong Kong.


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