(Reprinted from HKCER Letters, Vol.54, January 1999)
Hong Kong's Competitiveness, or
Do We Still Have the Hong Kong Advantage?
A year ago, my co-authors Edith Scott, David Dodwell, and I published a book about Hong Kong's economic future titled The Hong Kong Advantage (Oxford University Press). Recently, with Hong Kong's economy contracting, property prices down, the stock market down, and unemployment at the highest levels in recent memory, some have asked if it is time to rewrite or at least retitle our book.
Our answer is no, and I will explain why later. First, however we should note the contrast between discussions of Hong Kong today and those in the run-up to 1 July 1997. Last year, as many in the international media were predicting a meltdown of Hong Kong's social, political, and economic order after 1 July 1997, we wrote that our analysis of the interests of Hong Kong people, the Chinese leadership, and the international community indicated that there would be a strong impetus to make 'one country - two systems' work. In fact, the smoothness of the transition to Chinese administration over the last year has exceeded our expectations.
The discussion today is more about Hong Kong's economy and its future competitiveness. In order to look forward, I will spend a little time looking backward, because Hong Kong's economy is widely misunderstood, even in Hong Kong. Any description of Hong Kong's economy should be able to explain why it was prosperous for such a long time and why it is facing difficulties today.
Hong Kong's Economic Performance Through 1997
Historically, Hong Kong's economic performance has been quite strong. Real GDP grew at a rate of 7.5% per year from 1975 to 1995. During that time, real GDP quadrupled and real GDP per capita tripled. According to the World Bank, in 1997, Hong Kong's per capita income adjusted for purchasing power was fifth highest among the world's major economies. Historically, unemployment was rather low, often below 3%, and average unemployment in Hong Kong in 1997 was 2.2%.
Hong Kong has one of the most externally oriented economies in the world. Hong Kong's total trade to GDP ratio in 1997 was second only to Singapore among major economies. As of 1997, Hong Kong was the world's eighth leading trading economy, the world's ninth leading exporter of services, and by far the leader in intra-Asian trade. For the past five years, Hong Kong has been the fourth leading source of foreign direct investment in the world and by far the leader in intra-Asian investment.
The external orientation of Hong Kong's economy means that international competitiveness is critical to its prosperity. Historically, Hong Kong's competitiveness has been quite strong. In aggregate terms, Hong Kong has had the second most competitive economy in the world according to the World Economic Forum (1996, 1997, 1998) and the third most competitive economy according to Switzerland's Institute for Management Development (1996, 1997, 1998). At a more micro level, Hong Kong's economy is dominated by six internationally competitive clusters of related industries, which account for approximately 70% to 75% of the economy. These clusters are light manufacturing and trading, transportation, financial and business services, tourism and travel, and infrastructure and development. Each of these clusters contains a number of industries in which Hong Kong has been a leader in regional or global terms.
What has changed? The big differences are growth to negative 5% to 6%, per capita income down around 7%, unemployment up to 5.8%, and some of Hong Kong's clusters not doing so well, but more on that later.
Hong Kong's Services Economy
One feature that comes out of an examination of Hong Kong's competitiveness is the importance of the service sector. In fact, many people in Hong Kong talk about a transformation from a manufacturing economy to a service economy. In reality, Hong Kong always has had a services economy. Even at its lowest point in the last 20 years in 1984, services accounted for more than two-thirds of Hong Kong's output. By 1996, services accounted for 85% of Hong Kong's GDP, compared to 7% in manufacturing, 8% in other secondary, and 0% in primary activities, making Hong Kong more service-oriented than any national economy in the world.
The service sector also has dominated inbound foreign direct investment in Hong Kong. As of 1996, 92% of the stock of inbound foreign direct investment in Hong Kong was in the service sector, only 8% was in manufacturing. This is mirrored by the regional headquarters of multinational firms in Hong Kong according to the Hong Kong Industry Department, 87% of which came from the services sector.
Hong Kong has a very particular services economy. It is not geared toward consumer or personal services like most mature service economies, but toward producer services. This means that Hong Kong's economy rises and falls with business activity in Hong Kong, the Chinese Mainland, and the rest of the region. It also means that Hong Kong is not limited like consumer services economies to trading services back and forth among the local population.
From 1981 to 1996, output per employee in the manufacturing sector was roughly 60% of the output per worker in the service sector. The difference in value added per employee was even greater. On average, Hong Kong's economy has gained significantly from every employee that shifted from manufacturing to services.
Hong Kong's Metropolitan Economy
Though aggregate statistics show a shift from manufacturing to services, other aspects of the evolution of Hong Kong's economy have been more important. One such aspect has been Hong Kong's transformation from an enclave economy to a metropolitan economy. Since the opening of China, Hong Kong has moved from an enclave economy, artificially cut off from its natural hinterland to a metropolitan economy, closely linked to its Chinese hinterland as well as the rest of the region. Hong Kong's economic structure is an outlier today when compared to national economies, but not when compared to metropolitan economies. Today, Hong Kong's economic structure is roughly intermediate among major metropolitan economies. Its economic structure is much closer to that of New York City, or London, or Tokyo than to any national economy. Many people in Hong Kong still seem to think of Hong Kong as a national economy, not a metropolitan economy. Such a view denies economic reality and denies the fact that Hong Kong is part of China.
Viewing Hong Kong as a metropolitan economy helps us explain Hong Kong's emergence as a major business service center and it helps us understand what has happened to Hong Kong's manufacturing sector. Hong Kong's manufacturing sector has not disappeared, it has simply relocated. In 1980, nearly 100% of the exports of Hong Kong-based firms had final manufacturing done in Hong Kong itself. According to surveys carried out by the Hong Kong Trade Development Council, this figure was down to 36% by 1988 and under 10% by 1997. In 1997, the Chinese Mainland accounted for over 60% of final manufacturing and other economies accounted for just under 30%.
Just like in any other major metropolitan economy, manufacturing activities are decentralized as management, coordination, financial, and other higher value activities are concentrated into the city. Hong Kong is distinct in that the cost differential between most metropolitan economies and their hinterlands is on the order of 20% to 30%, while the cost differential between Hong Kong and its hinterland can be ten to one. Hong Kong also is distinct in that the shift that took New York roughly 40 years took Hong Kong ten years.
Hong Kong's Knowledge-based Economy
The most important shift in Hong Kong's economy over the last two decades, however, has not been from manufacturing to services, or from an enclave to a metropolitan economy, but from a manual economy to a knowledge-based economy. Some people claim that someday Hong Kong will be a knowledge-based economy. I would claim it is a knowledge-based economy today. In 1981, the portion of Hong Kong's employment in the categories "managers and administrators", "professionals and related", and "clerical" (knowledge workers and their support staff) was 21%. By 1996, this figure was 46%. The portion of managers and administrators increased from 3% to 12%, while those in professional and related and clerical increased from 6% to 17% and 11% to 17% respectively. Over the same period of time, the entire workforce grew from 2.4 million to some 3.2 million. Indicating that the number of knowledge-based workers in Hong Kong had nearly tripled.
The trends in Hong Kong's service and manufacturing sectors indicate that Hong Kong is increasingly acting as a knowledge-intensive co-ordination and management center for international business. In the process, Hong Kong and its firms have dramatically expanded their regional and global reach.
Hong Kong headquartered manufacturing and trading firms perform the most knowledge-intensive functions in Hong Kong, as they have decentralized the least knowledge intensive activities to the Chinese Mainland and elsewhere. Capitalizing on the comparative advantages of low-cost production in developing Asian economies and Hong Kong's own business connections, management expertise and infrastructure, Hong Kong companies have been able to expand their manufacturing and trading business beyond domestic production constraints and geographical boundaries. Although Hong Kong manufacturing and trading firms produce or contract for physical production activities outside of Hong Kong, the locus of the most knowledge-intensive and highest value-adding functions is Hong Kong
According to TDC surveys, 95% of Hong Kong manufacturing and trading companies intend to maintain their controlling headquarters in Hong Kong. Over 90% revealed their intention to increase or maintain their activities in trade finance, business negotiation, market research, insurance, marketing, trade documentation, and arbitration in Hong Kong. This is almost precisely the opposite of their plans for the Chinese Mainland, where the manufacturing is to be located.
Location of management and co-ordination centers in Hong Kong is not limited to Hong Kong headquartered firms. Overseas multinational companies perform similar management and co-ordination activities in Hong Kong. Hong Kong is the leading center for the regional headquarters and regional offices of multinational firms in the Asia-Pacific.
Of the more than 4,500 multinational firms that responded to the Industry Department's 1997 survey, 924 firms reported having a regional headquarter and another 1,606 a regional office in Hong Kong. The number of regional headquarters and regional offices in Hong Kong was several times that of any other center in the region.
Regional headquarters and regional office activities are of particular value to a local economy in that the establishment of a major regional center brings in many of the firm's most knowledge-intensive activities, such as senior management, regional co-ordination, finance, strategy formulation, product development, advanced marketing, and the generation of vital information. The headquarters often represents a locus of innovation and productivity growth. At the same time, a regional headquarters or major office embeds the host economy in the international business network of the multinational company and creates strong linkages between the host economy and the outside world. Headquarters investment also creates demand for advanced managerial skills and sophisticated support services, thus providing highly beneficial stimulus and spillover to the local economy.
Note that the key to Hong Kong's knowledge-intensive economy is based on activities rather than industries per se. The highest value activities that firms perform are their management, co-ordination, financial, market planning, and business negotiation activities. This is true of virtually any industry. This is important, because a center that can attract the high value activities that are necessary to perform in any industry will not be so subject to downturns in any single industry.
The emergence and growth of knowledge-intensive services and the knowledge-intensive activities of the manufacturing value-added chain has been the main reason for Hong Kong's prosperity over the last two decades.
Hong Kong's Advantages and the Asian Crisis
Hong Kong's development as a metropolitan and knowledge-based economy has allowed it to develop a number of advantages and take on a number of roles. We wrote in The Hong Kong Advantage that Hong Kong's combinations of a dynamic private sector and a clean and supportive government, strong local firms with an unmatched contingent of overseas firms, and of large firms that provide business infrastructure with smaller entrepreneurial firms hustling from deal to deal-were unique in Asia. We wrote that no other center in the region was ready to take over Hong Kong's roles as a modernizer for the economy of the Chinese Mainland, a packager and integrator of economic activity (matching demand for light manufactured goods in the West with sources of supply in the East and matching demand for business and financial services in the East with skills and capabilities developed in Hong Kong or imported from the West), a base for Japanese and Western multinationals, and the de facto capital of the overseas Chinese business network.
These statements were true then and are true now. And they help us understand Hong Kong's past prosperity, present difficulties, and future potential. Hong Kong's economy is closely tied to the rest of the region. Such ties have been and will be beneficial, but they create difficulties today. When intra-Asian trade and investment decline, Hong Kong, the region's leading center for trade and investment, suffers. When Western investors and foreign banks pull out of Asia, Hong Kong, the region's leading fund management center, suffers. When infrastructure finance evaporates and projects are shelved, Hong Kong, the leading center for putting together infrastructure projects for the region, suffers. And when these circumstances were coupled with a local and regional downturn in tourism and the bursting of a speculative bubble in the property and stock markets, the economy here contracts. One could argue that Hong Kong's relative position in the region has become stronger, not weaker, in the current crisis - not due to local improvement, but to the fact that many of the region's economies have fallen so much farther. This is no consolation to Hong Kong people who have lost their jobs, or have difficulty in paying their mortgage, but it provides much needed perspective.
This is particularly true when we realize that there has been a massive shift of economic activity away from Southeast Asia and toward Greater China. If we look at any comparison between market capitalization, foreign investments, or lists of Asia's leading firms, we see a massive reweighting away from Southeast Asia and toward Greater China. Despite Hong Kong's problems, it is better off next to the Chinese Mainland and Taiwan than it would be next to Indonesia, Malaysia, and Thailand.
What Does This All Mean?
What does this all mean? It means that Hong Kong still has many of its advantages. It means that Hong Kong is suffering more from a regional downturn and the bursting asset price bubble than it is from any loss of competitiveness. It also means that Hong Kong itself cannot lead a regional recovery, but will start to come back when business begins to pick up elsewhere in the region.
It means that before we debate what to do to improve Hong Kong's competitiveness, we have to understand the economy that is here. Hong Kong's economy is a service economy, a metropolitan economy, and a knowledge-intensive economy. It would be difficult and counterproductive to try to push the clock back. We also have to understand that the knowledge-intensity of the Hong Kong economy depends more on the activities companies perform here rather than the industries they are in.
It means that Hong Kong should benchmark, not against national economies, but against metropolitan economies, both inside and outside the region. It also means that Hong Kong must develop a clear sense of where its economy should go. Here, I have a great deal of sympathy with the arguments that Dr. Victor Fung made in the South China Morning Post a few weeks ago that Hong Kong needs to push to become Asia's world city, a city that can provide many of the functions for Asia that New York does for North America and London does for Europe. Hong Kong actually has a great deal in common with New York and London, but it has a long way to go in order to begin to match them in terms of economic influence.
If Hong Kong is to become a true international center like New York or London, it will need to tailor its education and training systems to develop the workforce necessary to extend its position as a management, co-ordination, and financial center. It will need to ensure that its infrastructure, particularly its communications and information infrastructure, are world class. It will need the most advanced and open markets with the most advanced regulatory systems in the region. It will need greater competition in the non-traded sector. It will need to ensure that property and wage costs are not so high that even high value activities get priced out of the market. Here the crisis has hurt Hong Kong since its costs have not fallen nearly as far as others.
It will need to make sure that the quality of life and physical environment can attract highly mobile knowledge workers. It will need to find ways to communicate goals, strategies, and policies far more effectively to local and international audiences. And finally, it will need to continue to have its economic structure determined by market forces rather than government fiat.
These are the major issues that we need to address going forward. Hong Kong has a strong position, but others are improving. Some centers in the region are taking aim at precisely the activities in which Hong Kong should excel. And international audiences, such as the EIU, the WTO, the Heritage Foundation, and others are skeptical of some of Hong Kong's position and policies. It would be a shame if Hong Kong got distracted and failed to capitalize on its advantages and the economic forces that eventually will point its way. On the other hand, if Hong Kong is able to pull together, learn from the downturn, avoid simplistic solutions, make the needed investments, and dare to be ambitious enough to seek a greater global role, then Hong Kong's competitiveness will be greater in the future than it is today.
Michael Enright is Sun Hung Kai Properties Professor of Business Administration at the School of Business, the University of Hong Kong.