This debate about Hong Kong's duplicity has been ongoing for ages.   Old news.

Commentary: H.K. struggles to stay in tune with China's boom

It was the duet that spanned the Pearl River Delta: Jackie Chan and Yang Liwei. Not your average singing duo, certainly - a Hong Kong action film star and an astronaut from mainland China. And it didn't even sound good. You were better off watching footage of their tune-challenged crooning session than hearing it.

Yet the Nov. 1 event said much about Hong Kong's outlook. A capacity crowd of 40,000 showed up to catch a glimpse of Yang, China's first astronaut, who carried out a 21-hour flight around the Earth last month. The turnout was one of the clearest signs that Hong Kongers have become less averse to the city's increasing connections with Beijing.

Many of the city's 7 million people remain suspicious of the central government, and Yang's six-day tour was all about stirring up conspicuous patriotism among them. Hong Kong leaders had been looking to stimulate Chinese nationalism; hence the move to import Yang and his Shenzhou 5 space capsule.

One senses less trepidation among Hong Kongers today about China. They still don't want Beijing clamping down on civil liberties or imposing security measures like Article 23. The legislation, expected to have a chilling effect on free speech, has been shelved for the moment - a comforting sign that public opinion still matters here.

Economics is forcing the issue. It hasn't escaped Hong Kongers that Beijing has gotten all the credit for the recovery that followed the retreat of severe acute respiratory syndrome. China's decision in July to relax rules on who can visit Hong Kong and how much they can spend is bolstering growth and the city's all-important property market.

Hong Kong is still trying to shake off the fallout from the SARS epidemic. Then again, the city was hardly booming even before the outbreak. Once indicators return to pre-SARS levels, the government still needs to change an economy that has lost relevance in Asia.

But more recently, Beijing has been wondering what to do with the place. Hong Kong is no longer laying golden eggs. It has fallen on hard times, punctuated by deflation, high unemployment and widespread pessimism.

Beijing bears some blame for imposing its own man as Hong Kong's leader. A history-making demonstration in July that drew 500,000 people to denounce the proposed anti-subversion legislation showed just how unpopular the dithering Tung is. Beijing's decision to stand by him has not gone over well.

Choosing spectacle over substance isn't good public-policy making. The government still seems more concerned with pleasing Beijing and executives that control the cartelized economy than with protecting the territory's interests. Tung should be thinking about where Hong Kong will be in 10 or 20 years, not gimmicks.

China's boom is nothing short of a godsend for Hong Kong. True, the "China effect" should not be overstated: dynamic mainland cities like Shanghai and Guangzhou are squeezing Hong Kong. At the same time, the gap in economic growth rates between Hong Kong and China has widened steadily since Britain handed over sovereignty in 1997. . What has changed is Beijing's approach to its Asian neighbors. China's leadership has embarked on a charm offensive to convince the region that it plans to be a benevolent economic power. The message: "You have far more to gain than to lose from our boom." . Indeed, many Asian governments have stopped voicing concerns about China and focused instead on how to ride its coattails. > . Hong Kong is uniquely positioned to do just that. It might not be the gateway to China that it once was, but the city's cultural ties with the mainland, its top-rate banking system and its popularity with multinational companies mean that Hong Kong, too, stands to benefit from China's boom. . Beijing could help, not merely by saying that it will allow Hong Kong to conduct its own affairs, but by proving it. Then, two of Asia's more interesting economies could, as the old adage says, make beautiful music together.  - by William Pesek  Bloomberg News  IHT  18 Nov 2003

Who Needs Hong Kong?
A city that found success as a gateway to China ponders its role now that the gates are gone.

Not long ago, Hong Kong residents would line up by the thousands for a chance to pay a small fortune for a 600-square-foot apartment that hadn't even been built. Earlier this year, there was a similar queue, only this time the line was to get into Hong Kong's first China Career Expo. Over two days, more than 12,000 people paid to meet with job recruiters from 100 mainland companies. "Sooner or later," said Ho Guo-kiang, 25, mulling a job offer in his native Hunan province, "a lot of Hong Kong people are going to have to find work in the mainland."

How the tables have turned. For decades after 1949, mainland Chinese risked their lives to get to Hong Kong, the British enclave off the south coast of China. For Hong Kong residents to be looking in the other direction is, well, strange.

The problem is not the political cataclysm many feared would follow the return of Hong Kong to Chinese sovereignty in 1997. With few exceptions, the handover has gone smoothly. People's Liberation Army troops stationed in Hong Kong have stayed in their barracks. The legal system retains the confidence of most of the business community. And the commercial playing field remains as level, and the press as free, as anywhere in Asia. Chief Executive Tung Chee-hwa is unpopular, but his re-selection for a second five-year term caused hardly a ripple in a place used to having its top officials imposed from afar.

What ails Hong Kong is economics, not politics. Unemployment has hit a record 7%, a shock to a city more accustomed to labor shortages. Property prices are down 60% since their peak, leaving as many as 200,000 people owing more than their properties are worth. Deflation is becoming endemic: Prices have fallen 2.2% in the past year and are expected to decline by at least as much this year. Personal bankruptcies have tripled since 1999, while consumer confidence has hit an all-time low.

This isn't just a garden-variety cyclical downturn. Hong Kong's troubles run deeper. Think of the city as a major brand with a great, almost exclusive franchise. Starting in 1949, whenever foreigners thought of doing business in China, they went to Hong Kong. A civilized place with great hotels, it prospered by serving as the comprador, or middleman, for those who wanted to buy or sell on the mainland. Since 1978, when Deng Xiaoping began his economic reform program, that role has expanded greatly, pushing Hong Kong from 23rd to ninth among the world's trading economies. It now handles about a third of China's $260 billion in exports.

The problem is that Hong Kong's China franchise has eroded--not, as many feared, because Beijing is keeping Hong Kong down, but because China is rising so fast. China's financial and legal systems remain opaque, backward, and occasionally frightening. But the country has made huge strides toward opening itself to the global economy. China's progress means that it just doesn't need Hong Kong as much. Multinationals like General Motors and Alcatel increasingly view Beijing, Shanghai, and Shenzhen as logical--and cheaper--alternatives to Hong Kong as their base of operations for China. "We had almost a lock on certain elements of China trade," says Hong Kong's Chief Financial Secretary, Antony Leung. Not any more.

Worse, from Hong Kong's standpoint, is that investment in China is going upmarket. In March, for example, Oracle rejected high-cost Hong Kong in favor of Shenzhen for a research and development center. "Hong Kong is not on the mainland," Derek Williams, executive vice president of Oracle's Asia Pacific division, told the press, "and we wanted to be where the action is."

Shanghai is Hong Kong's highest-profile competitor for bragging rights as China's top commercial city. Of course, it's hard to be a financial center with a nonconvertible currency. But given Beijing's focus on promoting Shanghai, and the rush of foreign firms to set up shop there, Shanghai could eventually push Hong Kong into second place. And Shanghai has a buzz and a hubris about it that make it feel a lot like Hong Kong in the 1980s. "Hong Kong is going through a very tough period," says Vincent Lo, chairman of Shui On Holdings and one of Hong Kong's leading real estate developers. "Now it's Shanghai that has the energy, vision, and opportunities."

Lo is putting his money where his mouth is: He has two ambitious projects in Shanghai, and more than half of his firm's assets are on the mainland. The Hong Kong government can hardly accuse him of being disloyal. Tung Chee-hwa's family firm, Orient Overseas, has invested more than $300 million in property development in Shanghai, Beijing, and Hangzhou.

So what's Hong Kong to do? For a start, it needs to understand what went wrong.

Fundamentally, Hong Kong got complacent. Like most operators with a lock on a market, it lost sight of what got it to the top. Yes, Hong Kong has been hit hard by the Asian financial crisis and the recent global slowdown. But many of its most troubling problems stem from within. Under British rule, the foundations for Hong Kong's economic success were real estate, low taxes, small government, a stable currency, an adaptable labor force, and an efficient but unobtrusive bureaucracy. Today all of those pillars are looking shaky.

The biggest problem stems from an addiction to ever-higher property values. The British instituted a system in which the government owned all land and would dribble out parcels for sale. Those revenues went into government coffers, a process that helped keep taxes down. Property was an artificial market made more so by the fact that many of the companies listed on the stock exchange were property firms that pulled in even more investment capital. One result: exorbitant rents, which have made Hong Kong one of the most expensive places in the world to do business.

Real estate prices soared even higher in the run-up to the 1997 handover. Fearing that the British would sell off land and take the money back to London, China insisted that Britain restrict land sales. By June 1997, a 600-square-foot apartment in a charmless housing development far from the city center was going for as much as $500,000.

The bubble burst when the post-handover government began putting more real estate on the block--just as Asia went into financial meltdown. The collapse of the property market has cost the treasury dearly. Four years ago land sales brought in $8.5 billion; last year the figure was about $1 billion, well short of the $3 billion target. Worse, the property-is-wealth mindset undermined entrepreneurism. Says Vincent Lo: "We've all been brought up to believe in buying assets, while the rest of the world has moved on to a knowledge-based economy."

Then there's the peg. Since 1983, the Hong Kong dollar has been linked to the U.S. dollar at a rate of 7.8 to one. The peg ended currency speculation and aided in Hong Kong's rise as an international financial center. But it has costs. When the financial crisis hit in 1997, many Asian countries were able to absorb some of the damage by devaluing; Hong Kong could not. One result was an immediate rise in unemployment, a trend that shows no sign of abating.

The problem, notes Chief Secretary Donald Tsang, Hong Kong's top civil servant, is that when an external shock rocks an economy that has a pegged currency, "the cost adjustment process is brutal and immediate." And it hurts even more in a place like Hong Kong, which doesn't have much of a social safety net.

The peg is likely to stay, at least for the next decade. With $112 billion in foreign reserves, no external debt, and a flexible economy, Hong Kong is the opposite of Argentina, and the peg is still considered key to investor confidence. Keeping it, however, will mean that salaries, which have remained stubbornly high, will probably have to come down. In effect, the peg "requires that you ask people to accept hardship," says Margaret Ng, the Legislative Council member who represents the legal profession. "That is the interface between economics and politics."

Hong Kong's fiscal health is an even bigger problem. In mid-April, Standard & Poor's threatened to downgrade its credit rating (currently AA-, with a stable outlook) if Hong Kong did not begin to close its deficit. Since 1997 public spending has risen from 17% to 24% of GDP as Tung has tried to present himself as a populist leader. Financial Secretary Leung believes that percentage is too high, out of tune with Hong Kong's free-market identity. In the March budget, he proposed spending increases (starting in 2003) of 1.5% a year, half the projected growth rate, and a civil service pay cut of 4.8%. The goal is to bring expenditures down to 20% of GDP by 2007.

Don't count on it. Even though the budget deficit hit $8.4 billion this fiscal year--2 1/2 times as high as the government's original estimate--Tung retains a soft spot for flashy spending. In February, days before the government's own task force forecast fiscal insolvency by 2008 barring drastic change, Tung announced a $77 billion, 15-year infrastructure master plan that included everything from a cruise ship terminal on the site of the old Kai Tak airport to a cable car to the Buddha statue on Lantau Island. The government, Tung blithely stated, would have no trouble financing the projects--all 1,600 of them.

Where's the money going to come from? "The tax base is too narrow," Leung concedes, "and we cannot continue to rely on land sales and investment income." Hong Kong's low income-tax rate of 15% (which only a minority of earners has to pay) and corporate profit tax rate of 16% are among its prime attractions. Fiddling with either could be disastrous. Instead, the IMF, as well as a government advisory committee, has suggested imposing a consumption tax on goods and services. But it won't be easy selling a tax increase during a recession to a notoriously tax-shy population.

Restructuring is hard work; giving stuff away is a lot easier. Perhaps that's why Hong Kong has made sweetheart deals like the 1999 agreement with Richard Li to jointly develop a high-tech residential and business center called Cyber-Port. The government put up the land for the $1.7 billion development, billing it as a way to attract high-tech companies to Hong Kong. The normally reticent business community was outraged, seeing it as a giveaway to Li (who happens to be the son of Li Ka-shing, Hong Kong's leading tycoon). The government also agreed to provide and prepare the land for a Disney theme park on Lantau Island, scheduled to open in 2005. "It feels like the level playing field is being tilted," says Ng. "The government doesn't think giving special deals to people is damaging to Hong Kong." The Disney deal also drew criticism as a subsidy to a foreign investor hardly lacking in resources.

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