Should we be worried about HK?

June 02, 2020 10:49
Photo: Reuters

Following China legislature’s approval of a resolution to introduce a national security law in Hong Kong last week, US President Donald Trump announced that his administration would “begin the process” of ending the American government’s special relationship with Hong Kong, and that he was withdrawing from the World Health Organization, as part of what the New York Times calls “a broad effort to retaliate against China” for the national security law.

I thought it would be useful to provide some information on the background, context and future impact of these political events concerning Hong Kong where many of us, as foreign investors, have called home.

The short answer is we don’t expect to see any impact on our business, or on Hong Kong’s status as an international financial center. We are confident that there will not be any change in the rule of law, independent judicial system or freedom of expression. In fact, we hope and expect to see more social stability after the details of the national security law are announced in August or September.

Hong Kong’s economy has been in a slump and will remain so for the foreseeable future. It had already sunk into recession last year, with Q3 and Q4 GDP tumbling 2.8% and 3%, respectively. It further contracted 8.9% in Q1 this year and will likely shrink even more in Q2, with no respite in sight.

There are three pillars to its economy: financial services, real estate and tourism. Tourism has now been permanently impaired, with adverse effects on the real estate sector as well. Only one pillar, financial services, remains strong.

Last year’s unrest and violence, much of which was targeted against mainland Chinese, caused the number of tourists to drop 39.1% in the second half, led by a 50% decline in mainland visitors. Tourism has completely dried up this year due to travel restrictions to fight Covid-19, decimating businesses ranging from airlines and hotels to retail, restaurants and entertainment. Many will simply not survive. While international travel will eventually resume after the pandemic, the drop in the number of mainland tourists is expected to be long term.

Since the handover of sovereignty from Britain to China in 1997, Hong Kong has operated under the framework of “one country two systems” under its mini-constitution, or the Basic Law, which states that “The laws previously in force in Hong Kong, that is, the common law, rules of equity, ordinances, subordinate legislation and customary law shall be maintained.” Under the Basic Law, Hong Kong is required to adopt a national security law. It has not been able to do so for 23 years. China’s legislature has the power to adopt such a law, but it has refrained from doing so until now – a change of heart presumably prompted by the violent unrest Hong Kong saw in the past year.

By law, Hong Kong’s defense and foreign affairs are the sole responsibility of the national government. It is for this reason that soldiers of the People’s Liberation Army are stationed in Hong Kong, as the offices of China’s foreign ministry. The absence of these obligations allows Hong Kong to maintain very low personal income tax rates, with no taxes on interests, dividends or capital gains, and to amass a fiscal reserves of more than HK$1 trillion (for a population of about 7.5 million).

While the national security law has prompted strong debate in Hong Kong and threats of renewed violence, we do not think that the law will alter the city’s way of life or its protected rights. Every major country has some kind of national security law. Any new law will be implemented and enforced by Hong Kong’s own judicial system. How do we know this? Macau, whose sovereignty was transferred from Portugal to China in 1999, has operated under the framework of “one country two systems” similar to Hong Kong. Macau adopted a national security law in 2009. To date, not a single person has been prosecuted under it.

This does not mean that Hong Kong’s new law will have no teeth; it simply means that the bar for being tried under a national security law, against secession, subversion, terrorism and foreign intervention, will likely be very high. (Those who were caught for engaging in violence last year were prosecuted under Hong Kong’s existing laws.) The national security law has not changed the nature of a free society in Macau and we don’t expect it to do so in Hong Kong.

Similarly, the PLA troops stationed in Hong Kong have only been seen outside of their barracks to sweep the streets in the past 23 years. There is no reason to expect this to change – they are here to guard the safety of China against foreign threats, but not for domestic law enforcement in Hong Kong.

So what is the US special relationship with Hong Kong? How will Hong Kong be affected if it is terminated? There are three main areas in this relationship, namely trade, travel and export controls. Under all three, the U.S. stands to benefit far more than Hong Kong:

The United States treats Hong Kong as a separate customs region from the rest of China and provides it with most favored nation status. Trade with Hong Kong is overwhelmingly in favor of the United States, generating the largest trade surplus by far of all America’s trading partners in the world – about US$31 billion in 2018. Hong Kong collects zero tariffs on imports of American goods and services, and exports to the United States were worth less than half a billion US dollars according to Hong Kong’s government statistics (not including re-exports). Most of Hong Kong’s trade volume with the U.S. is re-exported goods, which are taxed in the U.S. and other countries according to their country of origin. The trade privilege has been one way – in favor of the United States.

When it comes to travel, any Hong Kong passport holder needs to get a visa to visit the United States. Any American passport holder can visit Hong Kong visa-free. There is no usual diplomatic reciprocity here, but it is a one-way privilege granted by Hong Kong to America.

Regarding export controls, Hong Kong is exempt from the export controls which the United States imposes on China for certain high-technology equipment. But Hong Kong cannot transfer any such high-tech imports to any third party, including mainland China. We aren’t aware of any meaningful imports of high-tech equipment by Hong Kong. What for, in a city economy overwhelmingly based on services and real estate?

We hope that if the U.S. imposes import tariffs on Hong Kong goods and services, China will not retaliate likewise. If it does, Hong Kong people will suffer from increased prices for imported goods or won’t be able to afford America’s fine products. We expect any retaliation will be rhetorical and therefore won’t have a real effect on the economy.

Even though the local economy will remain in the doldrums for years to come, we expect the position of Hong Kong as an international financial center will remain unchanged. This is because only 10-20% of the revenue of all listed companies on the Stock Exchange of Hong Kong is derived from Hong Kong.

No city can be a real international financial center without possessing some necessary conditions, which include the free flow of capital, the free flow of information, the rule of law, fluency in a universal language (which is English, although of course Hong Kong also uses Chinese), and proximity to large economies and large pools of capital. In this regard, we expect that Hong Kong will remain unrivaled, at least in Asia, as an international financial center for a long time to come.

-- Contact us at [email protected]


Author of Out of the Gobi: My Story of China and America