25 October 2016
Hong Kong will feel the chills from Brexit given the city's relatively high exposure to the UK in trade and investments.
Hong Kong will feel the chills from Brexit given the city's relatively high exposure to the UK in trade and investments.

Hong Kong’s choice between hope and despair

Hong Kong’s financial secretary John Tsang Chun-wah warned recently that the city’s economy is facing its “worst time in 20 years”. In the past half a decade, growth has more than halved to close to 2.5 percent. With Brexit chills, some analysts fear a contraction.

The writing has been on the wall since the global financial crisis. Yet, critical decisions have been delayed.

Growth engines fading

Hong Kong’s old growth drivers remain necessary but are no longer enough. In the past, export-led growth fueled Asia’s tigers, including Hong Kong. Today, advanced West can no longer absorb Asian imports, and China’s growth is decelerating.

Last spring, concerns about Hong Kong’s economy led some ratings agencies to downgrade their outlook to negative, after similar action on China. But while the mainland can still rely on catch-up growth and rising living standards, Hong Kong’s aging economy must do with slower growth, stagnant living standards and income polarization.

In the past, Hong Kong’s property developers reduced risks by relying on prudent financial policies, funding flexibility and recurring income streams. Today, those positives have been offset by rising supply, slower growth, and the Fed’s potential rate hikes. However, developers’ presence in China’s urban growth centers has protected margins.

Similarly, retail sales can contribute to Hong Kong’s growth but not without the mainlanders’ role in the economy. The same goes for logistics and Chinese firms. Moreover, the city’s tourism is not viable without mainlanders who account for a large chunk of the total visitor arrivals.

Without China, Hong Kong would be left with only half its trade and a quarter of its foreign investment.

To Brexit or to OBOR

Unfortunately, Hong Kong is also highly vulnerable to Brexit spillovers. The city has relatively huge trade, investment and financial linkages with the UK.

With the Hong Kong dollar rising along with the US currency as investors scramble for safe havens, Hong Kong faces even greater headwinds than Singapore.

Last year, Hong Kong’s exports to the UK and the rest of the EU were 14 percent of the total, relatively highest in Asia and thus exposed to Brexit and EU risks. In contrast, China’s “One Belt One Road” (OBOR) initiative would allow Hong Kong to continue to benefit from trade and investment.

In the past, Hong Kong was China’s financial gateway to the world. Today, that role belongs increasingly to Shanghai and other megacities in the mainland. Indeed, Hong Kong’s sustained attractiveness as a financial hub is not viable without regional economic integration.

Guangdong is morphing into a global innovation hub, which can greatly complement Hong Kong’s business services. Without China, Hong Kong’s innovation, as measured by R&D as proportion of GDP, is below 0.8 percent – a third of that in Singapore and at the level of South Africa and Egypt.

From growth to equity

In the coming years, the current trend lines will become more prominent. At the time of Hong Kong’s handover in 1997, the US economy was almost 10 times bigger than that of China. Europe was integrating. Hong Kong’s living standards were 11 times higher than those in China.

Today – two decades later – the US economy is only a third larger than that of China. Europe faces fragmentation threats. Hong Kong’s living standards are on average about 3.7 times higher than those of China, but almost at par in certain districts in Shenzhen.

The key point is “on average”. In Hong Kong, income polarization has soared to alarming levels, as evidenced by the gini coefficient. Today, income polarization here is worse than that in Brazil and Zimbabwe.

Concerned with gloomy prospects, tycoon Li Ka-shing recently suggested that profits taxes could be raised so that the government can get additional income which can used to boost public spending and narrow the wealth gap.

In the absence of hope, despair among a few may undermine the living standards of many in the future.

However, there is a choice. Participating in Chinese economic growth can alleviate Hong Kong’s transition to greater equity. To thrive, small and open economies need growth, integration – and hope.

For more of Dr Dan Steinbock’ articles, see here

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Dr Dan Steinbock is the research director of international business at the India, China and America Institute (USA) and a visiting fellow at the Shanghai Institutes for International Studies (China) and at EU Center (Singapore).

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