The Emergence of Greater China: The Economic Integration of Mainland China, Taiwan and Hong Kong (Studies on the Chinese Economy)

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The Emergence of Greater China The Economic Integration of Mainland China, Taiwan and Hong Kong

Yun-Wing Sung

Studies on the Chinese Economy General Editors: Peter Nolan, Sinyi Professor of Chinese Management, Judge Institute of Management Studies, University of Cambridge, and Fellow of Jesus College, Cambridge, England; and Dong Fureng, Professor, Chinese Academy of Social Sciences, Beijing, China. This series analyses issues in China’s current economic development, and sheds light upon that process by examining China’s economic history. It contains a wide range of books on the Chinese economy past and present, and includes not only studies written by leading Western authorities, but also translations of the most important works on the Chinese economy produced within China. It intends to make a major contribution towards understanding this immensely important part of the world economy. Titles include: Thomas Chan, Noel Tracy and Zhu Wenhui CHINA’S EXPORT MIRACLE Sarah Cook, Shujie Yao and Juzhong Zhuang (editors) THE CHINESE ECONOMY UNDER TRANSITION Xu Dixin and Wu Chengming (editors) CHINESE CAPITALISM, 1522–1840 Christopher Findlay and Andrew Watson (editors) FOOD SECURITY AND ECONOMIC REFORM Samuel P. S. Ho and Y. Y. Kueh SUSTAINABLE ECONOMIC DEVELOPMENT IN SOUTH CHINA Kali P. Kalirajan and Yanrui Wu (editors) PRODUCTIVITY AND GROWTH IN CHINESE AGRICULTURE Bozhong Li AGRICULTURAL DEVELOPMENT IN JIANGNAN, 1620–1850 Alfred H. Y. Lin THE RURAL ECONOMY OF GUANGDONG, 1870–1937 Dic Lo MARKET AND INSTITUTIONAL REGULATION IN CHINESE INDUSTRIALIZATION Jun Ma THE CHINESE ECONOMY IN THE 1990s Guo Rongxing HOW THE CHINESE ECONOMY WORKS Sally Sargeson REWORKING CHINA’S PROLETARIAT Ng Sek Hong and Malcolm Warner CHINA’S TRADE UNIONS AND MANAGEMENT

Yun-Wing Sung THE EMERGENCE OF GREATER CHINA The Economic Integration of Mainland China, Taiwan and Hong Kong Terence Tsai CORPORATE ENVIRONMENTALISM IN CHINA AND TAIWAN Michael Twohey AUTHORITY AND WELFARE IN CHINA Carl E. Walter and Fraser J. T. Howie ‘TO GET RICH IS GLORIOUS!’ China’s Stock Markets in the ’80s and ’90s Michael Warner CHANGING WORKPLACE RELATIONS IN THE CHINESE ECONOMY Wang Xiao-qiang CHINA’S PRICE AND ENTERPRISE REFORM Xiaoping Xu CHINA’S FINANCIAL SYSTEM UNDER TRANSITION Yanni Yan INTERNATIONAL JOINT VENTURES IN CHINA Godfrey Yeung FOREIGN INVESTMENT AND SOCIO-ECONOMIC DEVELOPMENT IN CHINA The Case of Dongguan Wei-Wei Zhang TRANSFORMING CHINA Xiao-guang Zhang CHINA’S TRADE PATTERNS AND INTERNATIONAL COMPARATIVE ADVANTAGE

Studies on the Chinese Economy Series Standing Order ISBN 0–333–71502–0 (outside North America only) You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above. Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England

The Emergence of Greater China The Economic Integration of Mainland China, Taiwan and Hong Kong

Yun-Wing Sung

© Yun-Wing Sung 2005 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2005 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 0–333–62599–4 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Sun, Yun-Wing, 1948– The emergence of greater China: the economic integration of Mainland China, Taiwan and Hong Kong / Yun-Wing Sung. p. cm. – (Studies on the Chinese economy) Includes bibliographical references and index. ISBN 0–333–62599–4 1. China – Economic policy. 2. China – Commerce. 3. Hong Kong (China) – Commerce. 4. Taiwan – Commerce. I. Title. II. Series. HC427.95.S86 2005 330.951 – dc22 2004052098 10 9 8 15 13 12

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Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

To my wife, Pauline To my son, Samuel

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Contents List of Tables

x

List of Abbreviations

xii

Preface

xv

1 Greater China: An Emerging Economic Reality Impacts of the China Circle on the world economy Three layers of the China Circle Basic economic indicators of Greater China The emergence of Greater Southeast China The reintegration of Greater Southeast China Statistical pitfalls Organization of the book

1 7 9 10 12 14 15 17

2 China’s Opening and the Economic Integration of the China Circle China’s opening and economic reform Foreign investment Foreign capital in China China as an export base and as a market Foreign investment in China by source Foreign investment in the Mainland by industry China’s trade Benefits of foreign investment and trade Summary

18 18 20 21 25 26 32 35 38 39

3 Policy Changes and Economic Integration Economic integration Regional trading agreements History of economic integration of the China Circle Subregional economic integration Geographical proximity and cultural affinity Cultural and geographical affinity versus policy change Hong Kong–Mainland relations The first shift: Hong Kong’s estrangement from the Mainland The second shift: China’s opening and shallow reintegration The third shift: deep integration after 1997

41 41 42 43 43 44 46 47 49 51 54

vii

viii Contents

Labour market integration Mainland–Taiwan relations Taiwan’s policy changes and interactions with the Mainland Framework governing Taiwan–Mainland interactions Development of Taiwan–Mainland economic links in the 1990s Tensions and rapprochement across the Taiwan Strait Hong Kong–Taiwan relations A new brand of ‘new-style’ integration 4 Trade Between Hong Kong and the Mainland Complications of the Mainland’s trade statistics Hong Kong’s re-export statistics and the re-export margin Hong Kong as the middleman in the Mainland’s trade The Mainland’s trade with Hong Kong The Mainland’s commodity trade with Hong Kong Outward processing trade Major commodities traded and outward processing The Mainland’s trade with Hong Kong itself The Mainland’s trade with third economies via Hong Kong Guangdong’s trade with Hong Kong The Hong Kong–Guangdong production network Adjusting for the biases of outward processing trade The Mainland’s service trade with Hong Kong Prospects for Hong Kong as a middleman in the Mainland’s trade Conclusion 5 Hong Kong–Mainland Investments Hong Kong’s investment in China Evolution of Hong Kong’s investment in the Mainland Investment of Hong Kong in Guangdong Hong Kong investment: benefits to Hong Kong and the Mainland History of the Mainland’s investment in Hong Kong Size of Mainland investment in Hong Kong Mainland’s economic presence in major sectors of Hong Kong’s economy Organization and operation of Mainland companies in Hong Kong Determinants of Mainland investment in Hong Kong Political determinants of Chinese investment Future trends

59 61 62 63 64 66 68 71 73 74 75 77 84 86 88 91 92 93 94 95 96 99 104 107 109 109 112 117 120 123 123 125 127 130 133 136

Contents ix

6 Trade and Investment Involving Taiwan Taiwan’s investment in the Mainland Taiwan trade with China China’s commodity trade with Taiwan Service trade between the Mainland and Taiwan Trade and investment between Hong Kong and Taiwan Conclusion

137 137 141 153 156 156 160

7 An Overall View of Trade and Investment in the China Circle Investments of the China Circle Trade of the CEA Complications of trade statistics Re-examination of trade in the CEA The degree of integration of the CEA in trade Exports of the China Circle in the international context Conclusion

163 163 167 168 169 173 177 178

8 Policy Issues Impacts of the Mainland’s entry into the WTO Development of Mainland–Hong Kong policy coordination Coordination in regional infrastructure Coordination in border area issues Coordination in tourism Coordination in technology policy Integration of financial markets Coordination to stabilize the exchange rate Coordination on the Mainland’s WTO entry The Mainland and Hong Kong CEPA Breakthrough in Taiwan–Mainland Links? Social problems of economic integration Conclusion

179 180 186 189 191 193 195 196 197 199 199 206 207 209

9 Problems and Prospects of the China Circle Gross inefficiencies in the Mainland’s growth Problems of adjustment in the world market Tensions across the Taiwan Strait Stability of Hong Kong after 1997 The China Circle and the world trading system

210 210 213 216 217 221

Notes

223

References

226

Index

230

List of Tables 1.1 1.2 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 5.1 5.2 5.3 5.4 5.5 5.6

Basic indicators of Greater China, 2002 and 2003 Basic indicators of Greater Southeast China, 2002 and 2003 Contracted foreign capital in China Utilized foreign capital in China Contracted foreign direct investment in China by source Utilized foreign direct investment in China by source Share of Hong Kong and Taiwan (the duo) in Mainland’s inward FDI Contracted foreign direct investment by industry China’s trade since 1978 China’s export composition China: percentage share of FDI in gross domestic capital formation Hong Kong’s re-exports margin by origin Mainland’s trade via Shanghai and Hong Kong Hong Kong’s re-exports and offshore merchanting of goods related to the Mainland Gross margin of Hong Kong’s re-exports and offshore merchanting of goods related to the Mainland Mainland–Hong Kong trade Hong Kong’s trade involving outward processing in the Mainland since 1989 Commodity composition of Hong Kong’s trade with Mainland, 2003 Hong Kong exports and exports of Hong Kong firms in Hong Kong and Guangdong Exports of Hong Kong firms in Hong Kong and Guangdong by commodity, 2000 Hong Kong’s services trade with the Mainland Hong Kong’s outward FDI Mainland’s inward FDI Hong Kong’s investment in Mainland by industry Hong Kong’s investment in Guangdong Utilized foreign direct investment in China Hong Kong’s inward FDI from the Mainland x

10 11 22 23 27 28 32 33 36 37 38 76 78 83 85 86 89 91 97 100 102 110 111 114 117 119 124

List of Tables xi

5.7 5.8 5.9 5.10 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 6.11 6.12 6.13 6.14 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8

Mainland companies in Hong Kong by supervisory level of government (end of 1993) Major princeling companies in HK Role of Hong Kong as China’s gateway Mainland companies’ stake in the HK infrastructure sector in 1997 Taiwan’s investment in the Mainland Taiwan’s approved investment in the Mainland by area Taiwan’s cumulative approved investment by industry (1991 to Jan 2004) Taiwan–Mainland transhipment via Hong Kong Taiwan’s exports to Hong Kong and the Mainland Taiwan’s exports to the Mainland Taiwan’s imports from the Mainland Taiwan’s direct and indirect trade with the Mainland, 1986–2003 Mainland direct and indirect trade with Taiwan, 1986–2003 Hong Kong’s approved direct investment in Taiwan Hong Kong’s outward FDI in Taiwan Taiwan’s approved direct investment in Hong Kong Hong Kong’s inward FDI from Taiwan Distribution of Taiwan’s outward FDI Stock of FDI within the CEA, 2003 Exports of the CEA (Official Statistics), 2003 Exports of the CEA by region of consignment, 2003 Domestic exports of the CEA by final destination, 2003 Intra-regional exports share Intra-regional exports concentration ratios Concentration of FDI in the CEA Exports of the CEA: position among leading world exporters 2003

128 129 130 135 138 140 141 143 146 148 151 154 155 158 158 159 160 161 164 167 169 170 174 175 176 177

List of Abbreviations AFC APEC ARATS ASEAN ATC BOC CEA CEPA c.i.f. CITIC DPP EC EU FDI f.o.b. FTA GATT GDP GITIC GNP GSC HKSAR KMT MFA MFN MOFERT MOFTEC NAFTA NCNA NIE NPL NTR PPP PRC PRD RTA

Asian Financial Crisis Asian Pacific Economic Community Association for Relations Across the Taiwan Strait Association of South East Asian Nations Agreement on Textiles and Clothing Bank of China Chinese Economic Area Closer Economic Partnership Arrangement cost, insurance, and freight China International Trust and Investment Company Democratic Progressive Party European Community European Union foreign direct investment free on board free trade area General Agreement on Tariffs and Trade gross domestic product Guangdong International Trust and Investment Company gross national product Greater Southeast China Hong Kong Special Administrative Region Kuomintang (Nationalist Party) Multi-fibre Arrangement most favoured nation Ministry of Foreign Economic Relations and Trade Ministry of Foreign Trade and Economic Cooperation North American Free Trade Area New China News Agency newly industrializing economy non-performing loans normal trade relations purchasing power parity People’s Republic of China Pearl River Delta regional trading agreement xii

List of Abbreviations xiii

SARS SEF SEZ SMEs SOE WTO

severe acute respiratory syndrome Straits Exchange Foundation special economic zone small and medium-sized enterprises state-owned enterprise World Trade Organization

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Preface The fusion of know-how and capital from Hong Kong and Taiwan with the abundant labour resources of the Chinese Mainland has led to the emergence of a dynamic economy of ‘Greater China’ rivalling the USA, the European Union and Japan. This book analyses the emergence of the economy of Greater China from the opening of Mainland China in 1979 to 2004, when the Mainland and Hong Kong concluded a free trade agreement that symbolized the deep integration of the two parties. The book discusses the economic interactions and the nature and trend of trade and investment within Greater China. It examines the impacts of the emergence of Greater China on East Asia and the global economy, including the effects on the world market of China’s WTO entry and the liberalization of its imports of goods and services. The book concludes with a discussion of the problems and prospects of Greater China. The analysis of economic interactions within Greater China has been bedevilled by the many inconsistencies in the statistics on trade and investment flows within Greater China. Such inconsistencies arise partly because Taiwan requires its trade and investment with the Mainland be conducted indirectly via third parties (mostly via Hong Kong), and partly because Hong Kong is a major intermediary of the Mainland’s trade and investment. As a result, the bulk of the Mainland’s trade with Hong Kong is actually trade with third parties via Hong Kong. This book compares the data of the Mainland, Hong Kong and Taiwan on their bilateral flows of trade and investment, and reconciles the many inconsistencies to construct the best picture of trade and investment flows within Greater China. The idea of the book grew out of a course on the economy of Greater China that the author has taught at the Chinese University of Hong Kong since the mid-1990s. I wish to thank many students who have provided stimulation by their probing questions on the subject. Professor Peter Nolan of Cambridge University has taken a deep interest in this book and has given me invaluable advice and encouragement. I have also benefited greatly from the comments of an anonymous referee, assistance provided by the editors of Palgrave Macmillan and research support from the Hong Kong Institute of Asia-Pacific Studies. xv

xvi Preface

Needless to say, the views and any errors in this book are solely my responsibility. Last but not least, I would like to thank my wife for her affectionate encouragement and support. YUN-WING SUNG

1 Greater China: An Emerging Economic Reality

Since the inauguration of China’s open-door policy in 1979, extremely intense trade and investment flows have developed between Hong Kong and the Mainland, and also between Taiwan and the Mainland. It is well known that Hong Kong and Taiwan are respectively the first and second investors1 in the Chinese Mainland. Trade flows among the three economies are also huge. Since the early years of China’s open-door era, Hong Kong and Taiwan have relocated their labour-intensive, exportoriented industries to the Mainland, and investment from Hong Kong and Taiwan has been crucial to the Mainland’s economic reform and opening. The important role of Hong Kong in the Mainland’s reform and opening has been well recognized in the literature. To quote a study of the World Bank in 1994: China’s ‘Hong Kong connection’ has been vital to the success of its export drive. It was noted earlier that more than half of China’s exports to the rest of the world are now handled by Hong Kong. Although the role of Hong Kong as trade intermediary is critical, its contribution to the development of China’s exports goes much further. Most importantly 70 per cent of the cumulative value of $58.1 billion in Foreign Direct Investment (FDI) commitments to China has come from Hong Kong and been mostly directed to export-oriented joint-ventures in the coastal provinces, Guangdong in particular. (World Bank 1994:15) While the shares of Hong Kong and Taiwan in Mainland’s trade and investment have declined somewhat in recent years owing to the maturation of the Mainland investment environment, the roles of Hong 1

2 The Emergence of Greater China

Kong and Taiwan in the Mainland’s trade and investment are still important. In 2003, close to 55 per cent of the Mainland’s exports came from foreign-invested enterprises, and another 7.6 per cent from domestic enterprises undertaking subcontracting work (processing and assembling) for firms outside the Mainland. In other words, outside firms directly contributed to 63 per cent of the Mainland’s exports, and most of these firms are from Hong Kong and Taiwan. For brevity, Hong Kong and Taiwan will be referred to as the duo, and the duo plus the Mainland will be referred to as the trio. The trio are often referred to as Greater China, the China Circle or the Chinese Economic Area (CEA). Strictly speaking, the CEA should be the quad, as it also includes the economy of Macau. However, as Macau’s economy is very small it is often ignored in the discussion. In this book, the term Greater China is used in the economic rather than the political sense. Hong Kong and Macao reverted to China in 1997 and 1999, and Beijing’s insistence that Taiwan is part of China is recognized by most countries. However, the Mainland, Taiwan, Hong Kong and Macau are four separate customs territories, and trade and investment among the four take the form of external trade and investment. In economic literature, China’s economy usually means the Mainland’s economy instead of the trio or the quad. It is thus necessary to designate the economy of the trio or the quad as the economy of Greater China. In the early days of the Mainland’s open-door era, the duo were very influential in the Mainland’s development owing to their huge lead in level of economic development. The Mainland tailored its opening towards the duo, and gave Guangdong and Fujian special policy packages that vastly increased their autonomy. Guangdong established the three SEZs (special economic zones) of Shenzhen, Zhuhai and Shantou, which were geared towards Hong Kong and Macau, while Fujian established the Xiamen SEZ geared towards Taiwan. It must be stressed that Hong Kong has played a pivotal role in China’s opening, especially in the early years of the open policy. The development of Shenzhen, the most important SEZ, vividly illustrates the crucial role of Hong Kong in China’s opening. In January 1979, the State Council created an industrial export zone at Shekou, which is close to Hong Kong. The zone was to be developed and managed by the China Merchants Company, a Hong-Kong-based company controlled by the Chinese Ministry of Communications. According to Ho and Huenemann (1984:49), ‘Hong Kong business interests suggested that the zone be expanded to encompass property development and tourism

Greater China: An Emerging Economic Reality 3

and suggested the name “Special Economic Zone” to reflect the broader scope.’ Shekou thus became part of the Shenzhen SEZ. The 15 per cent corporate tax rate of SEZs was designed to match the profit tax rate of Hong Kong, which had been 15 per cent. Hong Kong capitalists were consulted by a number of Chinese officials, including Deng Xiaoping, on the opening of Hainan. In the early 1980s, the elites in Hong Kong, including established British capital in Hong Kong and also local Hong Kong capital, were aware of the importance of Hong Kong in China’s opening. They reckoned that, with successful economic development, in the long run China might be less dependent on Hong Kong. They thus seized the opportunity to open the negotiation with China on the settlement of the 1997 issue. They sought to extend the duration of British rule, perhaps at the cost of recognizing Chinese sovereignty in theory. China’s response of ‘one country, two systems’ was less than expected by the Hong Kong elites, though they reluctantly accepted it due to the lack of a viable alternative. Nevertheless, China’s willingness to sign an international treaty that guarantees capitalism in Hong Kong for 50 years after 1997 must be recognized as unprecedented in the history of Chinese Communism. It showed that the Chinese leadership is deeply aware of the economic value of Hong Kong to China. Both Hong Kong and Taiwan are strong in traditional labour-intensive, export-oriented industries: Hong Kong’s niches are in clothing, toys, watches and electronics, while Taiwan’s are in footwear, umbrellas, textiles and electronics. Such traditional industries have all but relocated to the Mainland. The opening of the Mainland came at the right time for Hong Kong and Taiwan as they had accumulated valuable human capital in the management and manufacturing of labourintensive products for exports from the 1950s to the 1970s. However, successful export-oriented industrialization had raised their wages, and their labour-intensive industries were threatened in the 1980s. The majority of manufacturing firms in Hong Kong and Taiwan were small, and lacked the ability to operate internationally; for example, to relocate to Southeast Asia. Without the opening of the Mainland, the vast majority of these small firms would have gone bankrupt. However, the opening of the Mainland allowed small firms to relocate to a culturally familiar environment and thereby utilize their valuable know-how to build a ‘global factory’ (production base dominating the world market) there. The roles of Hong Kong and Taiwan in Mainland’s development were somewhat different, as Hong Kong is stronger in services while Taiwan

4

The Emergence of Greater China

is stronger in industry, especially computer manufacturing. Hong Kong has transformed itself into a service hub, with little manufacturing left. Taiwan still has a core of more advanced industries, including computers and chemicals, which recently also started to relocate in the Mainland. As Taiwan still forbids direct links in transportation with the Mainland, most of Taiwan’s trade and investment with the Mainland are conducted via Hong Kong, strengthening the position of Hong Kong as China’s premier service hub. Hong Kong, and Taiwan to a lesser extent, have been pioneers in investing in the Mainland. As the Mainland’s investment environment matures, the share of the duo in the Mainland’s inward FDI has declined. Moreover, with rapid economic development in the Mainland, the economic relationship between the duo and the Mainland is changing. The relationship had been based on complementarity in factor endowment and skills, with the duo providing the capital, know-how, industrial design, and services in financing, order-taking and transportation, the Mainland cheap labour and land. In the production chain, the duo have specialize in processes at the front end (ordertaking, industrial design, sourcing of materials and components) and the back end (quality control, packaging, delivery, marketing), and have also provided overall management, coordination, logistics and financing, while the Mainland has specialized in the intermediate stages of processing and assembling, which tend to be labour-intensive. With rapid economic development, the Mainland has been able to undertake more and more of the stages in the production chain. Competition is emerging between the Mainland and the duo. For instance, the share of the Mainland’s trade re-exported via Hong Kong declined from a peak of 41.5 per cent in 1996 to 22 per cent in 2003 owing to competition from Mainland’s newly constructed ports in Shenzhen. The duo have to upgrade their skills and service quality to stay competitive. In the long run, the level of economic development of the coastal cities of the Mainland will approach that of the duo. This will not mean the end of economic cooperation among the trio. On the contrary, many more business opportunities will emerge with the economic development of the Mainland. A developed economy has a bigger market than an underdeveloped one. As a rule, trade and investment are much more intense among highly developed economies than between developed economies on the one hand and underdeveloped economies on the other. For instance, trade and investment are extremely intense among economies of the European Union, which is


composed of economies with similar rather than disparate levels of economic development. However, the nature of economic cooperation in the CEA will change gradually from one based on complementarity between developed and developing economies to one based on complementarity among equals. The former generates inter-industry trade while the latter generates intra-industry trade, which is based on product differentiation and the splitting up of the production chain among economies with strength in different niches. Intra-industry trade has already emerged within the trio. For instance, Hong Kong is exporting high-end clothing to the Mainland and importing low-end clothing in return. There is thriving trade in electronic components between Mainland and Taiwan. The relocation of the exports-oriented industries of the duo to the Mainland has turned the latter into a global factory for labourintensive products. By the late 1990s, the Mainland supplied 60 per cent or more of the footwear and toys imported by the USA. In 2000, the Mainland surpassed Taiwan as the world’s third largest producer of information technology equipment after the USA and Japan. With rapid economic development and trade liberalization, the Mainland is also emerging as a very big market. The Mainland surpassed the USA to become the world’s largest market for mobile phones in mid2001, even though the penetration rate was only 13 per cent of the population. In 2002, the Mainland surpassed Japan to become the world’s second largest PC market and also the world’s second largest internet user. China’s entry to the WTO in late 2001 has enhanced the attraction of the Mainland’s market. In recent years, the duo have suffered from the Asian financial crisis of 1997–8, and also from economic competition from the Mainland. Relocation of low-end jobs to the Mainland has led to structural unemployment in the duo. On the other hand, the rapid growth of the Mainland’s market presented golden opportunities for the duo. The duo have to strengthen their niches, and avoid areas where the Mainland is strong. Unlike the early days of the Mainland’s opening, when the duo had the upper hand owing to their huge lead in economic development, the Mainland now has the upper hand as a result of its vast market and development potential. In the early 1980s, the Mainland recognized the strength of the duo and formulated its policies to capture business opportunities from the duo – for example, the creation of SEZs was aimed specifically at the duo. Now, the duo have to recognize the strength of the Mainland and adjust their policies accordingly to capture business opportunities from it. For instance, Hong Kong proposed the


forming of an FTA (free trade area) with the Mainland in late 2001, and the proposal was realized as the Mainland–Hong Kong CEPA (Closer Economic Partnership Arrangement) in mid-2003. Taiwan proposed to establish direct links with the Mainland in 2000. However, the proposal has yet to be realized because of political disagreements. The Asian Financial Crisis struck Hong Kong shortly after Hong Kong’s reversion to China in mid-1997. Hong Kong’s gross domestic product (GDP) contracted by 5.3 per cent in 1998, the first record of negative annual growth since official GDP figures were available since 1961. Though the Hong Kong economy recovered in 1999–2000, the slowdown of the US economy and the 11 September terrorist attack led to another recession, and GDP growth fell to 0.5 per cent in 2001. Recovery in the second half of 2002 was interrupted by the outbreak of SARS (severe acute respiratory syndrome) in March 2003. Unemployment in Hong Kong reached a record high of 8.7 per cent in mid-2003, partly because of the relocation of low-end jobs in manufacturing and services to the Mainland. Economic hardship and political discontent led to a massive half-million-strong demonstration against the government on 1 July 2003, the sixth anniversary of Hong Kong’s reversion to China. Since the Asian Financial Crisis, Hong Kong has tried to leverage on its Mainland connections to boost its economy. Measures included relaxation of controls against tourists and skilled workers from the Mainland, promotion of economic integration with the PRD (Pearl River Delta), the natural hinterland of Hong Kong and the premier economic region of Guangdong. Hong Kong also proposed forming an FTA with the Mainland. Beijing responded favourably because it was alarmed by the economic malaise in Hong Kong. The discontent that led to the massive protest against the Hong Kong government on 1 July 2003 prompted Beijing to shore up Hong Kong’s economy with a spate of measures announced around mid-2003. The Mainland and Hong Kong CEPA was signed on 29 June 2003. This was the first free-trade agreement for either the Mainland or Hong Kong. In late July 2003, Mainlanders were allowed to tour Hong Kong individually (as opposed to in group tours), starting with four cities in the PRD. The scheme was extended to Shenzhen, Guangzhou, Beijing and Shanghai in September 2003. The scheme is expected to bring millions of Mainland tourists to Hong Kong every year. In early August 2003, Hong Kong and Guangdong announced their intention to turn the Pearl River Delta into one of the world’s ‘economic superzones’, with Hong Kong as the hub. A bridge linking Hong Kong, Zhuhai and Macau proposed by Hong


Kong also received favourable response from Guangdong. Economic crisis in Hong Kong clearly speeded up its economic integration with the Mainland. Beijing’s measures, together with a weak US dollar and global economic expansion, sparked a sharp economic recovery in Hong Kong. In 2003 the real growth rate of GDP swung from minus 0.5 per cent in the second quarter to a healthy 4 per cent in the third. The unemployment rate also dropped to 7.3 per cent at the end of 2003 from the peak of 8.7 per cent in mid-2003. Taiwan’s economy also suffered from the Asian financial crisis, the 11 September terrorist attack and SARS. While economic difficulties have spurred Taiwan towards closer links with the Mainland, Taiwan was less active than Hong Kong in capturing the Mainland’s market, owing to political animosity. Taiwan’s GDP contracted by 1.9 per cent in 2001, the first record of negative annual growth since data were available in 1951. Taiwan’s unemployment rate broke the 5 per cent barrier in 2002, the highest since 1964 when statistics on unemployment were regularly available. While Taiwan’s business community has been eager to improve relations with the Mainland, the election of Chen Shui-bian, candidate of the pro-independence Democratic Progressive Party (DPP) to Taiwan’s presidency in 2000, exacerbated political tensions across the Taiwan Strait. Though Taiwan significantly relaxed its restrictions on large-scale investments in the Mainland in late 2001, the long-awaited breakthrough on direct links must wait for the diffusion of political tensions.

Impacts of the China Circle on the world economy In the reform era since 1979, China has been one of the world’s fastestgrowing economies. From 1979 to 2002, China’s real GDP has grown at the average annual rate of 9.3 per cent. Using nominal exchange rates, China’s 2001 GDP was US$1.2 trillion, 28 per cent of Japan’s and 12 per cent of that of the USA. However, nominal exchange rates underestimate the size of the Chinese economy because Chinese prices are much lower than those in developed countries. Using the purchasing power parity (PPP) measurements of the International Monetary Fund, China’s 2001 GDP should be US$5.6 trillion, higher than Japan’s (US$3.5 trillion), and 55 per cent of the size of the USA’s. The International Monetary Fund estimates that, using PPP measurements, China could surpass the USA as the world’s largest economy as early as 2007, though China’s per capita GDP would still be quite low. While PPP estimates


are subject to some margin of error, the Chinese economy certainly has the potential to rival that of the USA in size as a result of the huge Chinese population. Economic reforms and China’s opening have been the two most important factors in China’s rapid growth. Hong Kong and Taiwan have been crucial to China’s opening and reform. The economic miracles that transformed Hong Kong and Taiwan in the 1960s and 1970s provide the Mainland with models of modern Chinese societies. Hong Kong has been the foremost investor in the Mainland since 1979, accounting for around half of the cumulative foreign direct investment (FDI) in China. Hong Kong’s FDI in the Mainland is so large that Hong Kong has been the largest source of FDI in Asia, surpassing Japan since 1993. China became the second largest recipient of FDI in the world after the USA from 1993 to 1997, but slipped to third or fourth from 1998 to 2001 as a result of the Asian financial crisis, after which, boosted by WTO entry, the Mainland surpassed the USA to become the world’s number one recipient of FDI in 2002.2 The Mainland surpassed the UK to become the foremost investor in Hong Kong in 1998. At the end of 2002, China accounted for around 30 per cent of the stock of inward FDI in Hong Kong. Mainland–Hong Kong trade is also large, as Hong Kong has served as the Mainland’s entrepot. In 2002, 25 per cent of the Mainland’s trade went through Hong Kong in the form of entrepot trade. Mainland-related entrepot trade accounted for 38 per cent of Hong Kong’s trade. Including the entrepot trade via Hong Kong, China has been Hong Kong’s foremost trading partner since 1985, and Hong Kong has been China’s foremost trading partner since 1987. In 2003, Hong Kong accounted for 23 per cent of China’s trade and China for 42 per cent of Hong Kong’s. Though Taiwan has liberalized economic relations with the Mainland only since 1987, it rapidly become the second largest investor in the Mainland in 1993. The Mainland surpassed Japan to become Taiwan’s second largest market in 1992, and surpassed the USA to become Taiwan’s foremost market in 2003. Since 1993, Taiwan has surpassed Hong Kong and the USA to become the Mainland’s second largest supplier (after Japan). The impact of the China Circle on world trade and investment is substantial. The exports and inward FDI of the ASEAN (Association of Southeast Asian Nations) suffered from competition with China from the early 1990s onwards, and this was an important factor in the Asian financial crisis, which started with the devaluation of the Thai baht in mid-1997.


China’s exports rose from US$8.8 bn in 1978 to US$438 bn in 2003. Its rank in the world as an exporter rose from twenty-fourth in 1978 to fourth in 2003. In 2003, while world trade only grew by 3 per cent, China’s exports grew by nearly 35 per cent. The USA is China’s largest market, taking close to 40 per cent of Chinese exports. The US trade deficit with China has surged, reaching US$124 bn. in 2003. China has surpassed Japan to become the largest deficit-trading partner of the USA since 2000. This has generated considerable friction with the USA. Hong Kong and Taiwan are also large exporters. The total exports of the trio to other regions were US$528 bn in 2003, making the CEA the third largest exporter in the world.3

Three layers of the China Circle In terms of the degree of economic integration, there are three concentric layers of the China Circle, with the Hong Kong–Guangdong economic nexus or Greater Hong Kong as the core, Greater Southeast China (GSC) covering Hong Kong, Taiwan and the southeast coastal provinces of the Mainland (Guangdong, Fujian, Zhejiang, Jiangsu and Shanghai) as the inner layer, and Greater China or the Chinese Economic Area (CEA) covering Hong Kong, Taiwan and the Mainland as the outer layer. Hong Kong is the pivot for the integration of the China Circle. The trio have important links to the ASEAN, and many of these are associated with ethnically Chinese businesses. However, extension of the China Circle to encompass Chinese business networks in the ASEAN would be too nebulous, and it is best to confine our attention to the trio. Greater Southeast China includes the two most dynamic regions of the CEA, namely, the Pearl River Delta (PRD) with Hong Kong as the hub and the Yangzi Delta with Shanghai as the hub. The links of Hong Kong and Taiwan with both deltas are very strong in terms of both trade and investment and also personal connections. The Hong Kong and Taiwanese communities in Shanghai number respectively around 100 000 and 300 000. Hong Kong’s ties with the PRD are much stronger than those with Shanghai, as the PRD is the natural hinterland of Hong Kong. Hong Kong residents made a total of over 55 million person-trips to the Mainland in 2002 (an average of 8.2 trips per person), and most of these were to the PRD. At the end of 2001, Hong Kong firms employed directly or indirectly an estimated 10 million workers in Guangdong (Federation of Hong Kong Industries 2003:8). An estimated

10


50 000 Hong Kong residents live in Shenzhen, the SEZ adjacent to Hong Kong. The impetus of the integration of the CEA came primarily from the opening and reform of China and secondarily from the economic liberalization of Taiwan. Despite economic liberalization, there are still many barriers to economic integration of the CEA; foremost are the remnants of central economic planning in China and Taiwan’s ban on direct links with the Mainland in transportation. Though there is no institutional framework coordinating the economic integration of the CEA, geographic and cultural proximity and the huge gains from economic complementarities have overcome the many barriers to economic interactions. The efficient intermediary role of Hong Kong is also important. Private initiative and market forces have led to intense trade and investment flows within the CEA despite the lack of an institutional framework.

Basic economic indicators of Greater China Tables 1.1 and 1.2 show respectively the basic economic indicators of the China Circle and GSC in 2002 and 2003. The China Circle includes Table 1.1 Basic indicators of Greater China, 2002 and 2003

2002 Indicators Area (km2) Population (millions) GDP (US$ bn) GDP per capita (US$) Average growth rate (78–02, %) Exports (US$ bn) 2003 Indicators GDP (US$ bn) GDP per capita (US$) 2003 growth rate % Exports (US$ bn)

Hong Kong

Taiwan

1 098 6.8 163.0 24 010 3.98

36 188 22.5 283.2 12 576 5.50

Macau

19 0.4 6.8 15 418 2.03*

Mainland

9 600 000 1 284.5 1 237.1 963 8.04

200.1† 16.8‡

130.6

2.4

325.6

158.6 23 311 3.07 224.6† 15.7‡

286.8 12 751 2.80 144.2

7.9 17 782 15.60 2.6

1 416 1 090 8.45 438.4

* Growth rate for 1982–2002. † Total exports (including re-exports). ‡ Domestic exports (exports of Hong Kong goods). Source: Data are from the websites of the respective governments.

Greater China: An Emerging Economic Reality 11 Table 1.2 Basic indicators of Greater Southeast China, 2002 and 2003

2002 indicators Area (km2) Population (million) GDP (US$ bn) GDP per capita (US$) Average growth rate (78–02, %) Exports (US$ bn) 2003 indicators GDP (US$ bn) 2003 growth rate (%) Exports (US$ bn)

Guangdong

Fujian

Zhe jiang

Shang hai

Jiangsu

Total

177 901 78.6

121 400 34.7

101 800 46.5

6 341 16.3

102 600 73.8

510 042 249.9

141.0 1 795

56.6 1 630

92.7 1 993

65.3 4 009

128.5 1 741

484.1 1 937

11.1

11.3

12.0

8.8

11.1

10.6

118.4

17.4

29.4

32.1

38.5

235.8

163.2 13.6

63.6 11.5

111.6 14.0

75.8 11.8

151.1 13.5

565.3 13.2

159.9

21.1

41.6

48.5

59.1

323.2

Sources: Data are from the websites of the respective provincial governments. The 1978–2002 average real growth rates are obtained with data from the respective provincial Statistical Yearbooks.

the Mainland, Hong Kong, Macau and Taiwan. In 2003, the GDP of Taiwan was 1.8 times that of Hong Kong. The GDP of the Mainland was 4.9 times that of Taiwan and 8.9 times that of Hong Kong. As mentioned above, the Mainland GDP is biased downwards because of price differences. The Mainland’s 2003 exports of US$438 bn surpassed Taiwan’s exports of US$144 bn and also vastly surpassed Hong Kong’s domestic exports (that is, exports made domestically in Hong Kong) of US$16 bn. The figure for Hong Kong’s total exports (that is, including re-exports) of US$225 bn is large because Hong Kong is re-exporting Chinese products to third countries and third-country products to China. In other words, Hong Kong is China’s gateway to the world in commodity trade. Macau’s economy is much smaller than that of Hong Kong and can be regarded as an appendage of the Hong Kong economy. This book will concentrate on economic interdependence among China, Hong Kong and Taiwan, or the trio, and there will be no separate treatment of Macau.

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The emergence of Greater Southeast China The population of the GSC was 20 per cent of that of the Mainland, but its GDP was close to 40 per cent of the Mainland’s. Its 2003 exports were 74 per cent of the Mainland’s, largely because the GSC, especially Guangdong, is highly export-oriented. The average annual growth rate of per capita GDP of the GSC in the reform era (1978–2002) was 10.6 per cent, appreciably higher than the national average of 8 per cent. Guangdong and Fujian were the first provinces in GSC to exhibit dynamic growth. In 1979, to tap the resources of Hong Kong, Macau and Taiwan, Beijing gave Guangdong and Fujian special policy packages that vastly increased their autonomy, including the management of foreign trade and investment and the authority to operate SEZs. Guangdong As a result of its connections with Hong Kong, Guangdong has risen rapidly from a comparatively backward province to the leading province in China in the reform era. Ranked seventh in its GDP among the provinces in 1978, it rose to the top in 1989. Before the reform era, Shanghai was the leading region in China. Its shares in China’s GDP, industrial output and exports in 1978 were 7.5 per cent, 12.1 per cent and 29.7 per cent respectively. However, Guangdong grew much faster than Shanghai, and surpassed Shanghai in GDP in 1983, in exports in 1986 and in industrial output in 1989. Guangdong has been China’s leading province in inward foreign investment since 1979, in exports since 1986, in GDP since 1989 and in industrial output since 1995. In 2003, while Jiangsu has surpassed Guangdong in inward FDI due to the very rapid growth of the Greater Yangzi Delta (Shanghai, Jiangsu and Zhejiang), Guangdong remained the number one province in GDP, exports and industrial output. Shanghai The opening of Pudong in 1990 has revitalized Shanghai’s performance. From 1978 to 1991, Shanghai’s average annual growth in per capita GDP was only 6.1 per cent. This was appreciably lower than the national average of 7.5 per cent in that period. Shanghai’s development was shackled by central planning. From 1991 to 2002, Shanghai’s average annual growth in per capita GDP leapt to 10.8 per cent, which is substantially higher than the national average 9.1 per cent. As a result of its central location at the


mouth of the Yangzi River, Shanghai is a better place from which to penetrate the vast Mainland market than is Shenzhen. Shanghai’s skill endowment is also much better than that of Guangdong. Shanghai’s stock market has surpassed that of Shenzhen, and Shanghai is now the undisputed financial centre and service hub of the Mainland. Besides attracting FDI in services, it also has attracted a lot of FDI in manufacturing. Shanghai, together with Suzhou (a major city in Jiangsu) nearby, now vies with Beijing and Shenzhen to be China’s silicon valley. Despite its recent rapid growth, however, Shanghai is much less export-oriented than Guangdong. In 2003, Shanghai’s GDP was 46 per cent of Guangdong’s, but Shanghai’s exports were only 32 per cent of Guangdong’s. This is due to the legacy of China’s import substitution strategy in the pre-reform era. Under protection, Shanghai built up a vast industrial complex composed of state-owned enterprises (SOEs), and the protected industries were often inefficient. The inefficiencies of import substitution and state ownership have handicapped the development of Shanghai down to the present. Fujian Fujian has benefited from Taiwanese investment, especially after Taiwan liberalized its prohibitions on visits to the Mainland in late 1987. Seventy per cent of Taiwan’s population originated from the southern part of Fujian Province, where Xiamen was the economic capital. Fujian is the third destination of Taiwan’s investment in the Mainland, with around 9 per cent of Taiwan’s cumulative outward FDI by the end of 2003. Jiangsu/Shanghai and Guangdong are respectively the first and second destinations of Taiwanese investment, with respectively 41 per cent and 31 per cent of Taiwan’s cumulative outward FDI by the end of 2003. Jiangsu Jiangsu has long been a dynamic province in the reform era. It is rich in agricultural resources and also in human capital. In the 1980s, when Shanghai industries were still shackled by planning, Jiangsu’s rural collective enterprises operated under the market and they also benefited from proximity to Shanghai’s expertise. In the 1980s, Jiangsu’s rural industrialization was very successful. The sunan (southern Jiangsu) model of rural industrialization based on collective enterprises is held up as a national model. The other model of rural industrialization, the wenzhou model in Zhejiang province, is based on private enterprises.

14


In the 1990s, the sunan model of rural industrialization ran into problems. As is well known, the property rights of collective enterprises were not well defined. This had not been a problem in the early stage of reform when collective enterprises were small. Moreover, in the semimarketized environment of the 1980s, interventions from local governments were often necessary for successful operation. However, in the more mature market of the 1990s, collective enterprises lost their advantage. Jiangsu nevertheless benefited from the opening of Shanghai thanks to the latter’s proximity. Many foreign investors have invested in the industrial parks of Suzhou, as they are near Shanghai and the costs are lower than Shanghai. Since 2000, Jiangsu plus Shangai have surpassed Guangdong as the prime destination of Taiwanese investment. Suzhou has become an important base for electronics products. Zhejiang Zhejiang has no special ties with Taiwan and Hong Kong, and it does not have the benefit of a central location. It has not attracted a lot of foreign investment. Its development was based on indigenous, private capital on the renowned wenzhou model. As transportation over the mountainous terrain to wenzhou has proved inconvenient, central control is not as tight and private enterprises have more space to develop. Northern Zhejiang has also benefited from its proximity to Shanghai. Zhejiang’s private enterprises have been extremely dynamic. Zhejiang is the fastest-growing region in the GSC.

The reintegration of Greater Southeast China During the cold war era, Hong Kong was largely cut off from its hinterland, and the Mainland–Taiwan ties were completely severed. The end of the cold war and the inauguration of economic reforms and opening in China in December 1978 heralded a new era. On New Year’s Day 1979, the USA established diplomatic relations with the Mainland and broke off its long-standing diplomatic relations with Taiwan. Ties between Hong Kong and the Mainland developed very rapidly. The development of Mainland–Taiwan ties mainly took place after November 1987 when Taiwan lifted its ban on visits to the Mainland. In 1984, the Sino–British Declaration over the future of Hong Kong was signed. Hong Kong would revert to Chinese sovereignty in mid1997 while preserving its capitalist system for 50 years under the formula of ‘one country, two systems’. In economic terms, Hong Kong


is an autonomous entity. Hong Kong is a separate customs territory and a founding member of the World Trade Organization (WTO). It has an independent fiscal and monetary system, issuing its own currency that is linked to the US dollar instead of the Chinese renminbi. It issues its own passport and retains its legal system, maintaining its own court of appeal. It runs its internal affairs without interference from the central government, except in matters of defence and foreign affairs. After the reversion of Hong Kong to Chinese sovereignty in 1997, Beijing has largely honoured its promise of maintaining an autonomous Hong Kong. The intimate and multifaceted links between Hong Kong and the Mainland and the big differences between the two systems have inevitably led to various problems, but Beijing has exhibited remarkable restraint in its handling of matters related to Hong Kong. Though Hong Kong has suffered two recessions since reversion in 1997, Hong Kong’s trade and investments with the Mainland have continued to grow. Economic integration with the Mainland has become the cornerstone of Hong Kong’s economic strategy. Despite the rapid development of Mainland–Taiwan economic ties, political relations have at times been strained, especially after the election of Chen Shui-bian, candidate of the pro-independence DPP, to Taiwan’s presidency in 2000. The intricacies of Mainland–Taiwan relations will be discussed later in Chapter 3. The Mainland has nevertheless become Taiwan’s number one market and destination of investment. The outbreak of SARS in Guangdong in early 2003 and its rapid transmission to Hong Kong and Taiwan demonstrated that the ties among the trio are so close that events in one area can have very serious consequences throughout Greater China. It also shows that economic integration can generate major social and public health problems. Besides public health, illegal immigration and cross-border crime are major social problems that need to be managed. However, such problems can be contained by policy coordination in the trio.

Statistical pitfalls It must be emphasized that official statistics of trade and investment among the Chinese economies are highly inaccurate, partly because Taiwan requires its trade and investment with the Mainland be conducted indirectly via third territories (mostly via Hong Kong). This book carefully compares data from the trio, and also relies on the entrepot trade data in Hong Kong to give an accurate picture of trade and investment among the trio.

16


Pitfalls of investment statistics A more accurate picture of bilateral investment flows can be obtained by comparing data on inward FDI and outward FDI. Outward FDI is usually understated in economies with foreign exchange control, which include Taiwan and especially the Mainland. For instance, according to UN data, the Mainland’s outward FDI in 2001 was only US$1775 m. However, according to Hong Kong data, Mainland’s inward FDI in 2001 in Hong Kong alone was US$4936 m. Hong Kong’s direct investment in the Mainland is grossly overstated, as many multinational companies like to channel capital to the Mainland via their Hong Kong subsidiaries because Hong Kong has the required expertise and is the foremost hub of the Mainland’s trade and investment. Mainland enterprises also invest in the Mainland via their Hong Kong subsidiaries to take advantage of preferences given to foreign investors. This ‘round tripping’ of Mainland capital is estimated to account for around 25 to 40 per cent of Hong Kong’s direct investment in the Mainland. According to Mainland statistics on inward FDI, the 2002 cumulative stock of Hong Kong’s direct investment in the Mainland was US$205 bn, or 46 per cent of Mainland’s total. As there is no good way to trace the ultimate source of direct investment channelled via Hong Kong, this book has to rely on the Mainland’s statistics on inward FDI from Hong Kong, though the figure must be interpreted with the caveats noted above. Since Hong Kong is an international financial centre, it is very difficult to trace the nationality of capital. Hong Kong is certainly both an important source as well as an intermediary of direct investment in the Mainland. Both the Mainland and Taiwan understate Taiwan’s investment in the Mainland because Taiwan requires its investment in the Mainland be conducted indirectly via companies incorporated in third territories. Taiwan also forbids outward investment in industries still competitive in Taiwan. Such investments nevertheless take place covertly under partnership with third-country firms. According to Mainland’s statistics, the 2001 cumulative stock of Taiwan’s FDI in the Mainland was US$29 bn (utilized investment), or only 16 per cent of Hong Kong’s. Taiwan’s figure on its outward FDI in the Mainland (approval basis) was even smaller at US$20 bn. However, a Taiwanese magazine estimated that the 2001 stock of Taiwan’s investment in the Mainland was as large as US$139 bn, or nearly five times the Mainland’s figure (Xu 2002:41). As there is no reliable estimate of Taiwanese investment in the Mainland, this book has to rely on Mainland statistics on inward FDI from Taiwan, though the figures must again be interpreted with care.


Pitfalls of trade statistics As Taiwan requires its trade with the Mainland to be conducted via third territories, mostly via Hong Kong, Taiwan understates its trade with the Mainland, but overstates its trade with Hong Kong. Moreover, a substantial portion of Mainland’s trade with other economies is conducted through Hong Kong, with the result that the Mainland overstates its exports to Hong Kong but understates its exports to other economies, including Taiwan and the USA. Other economies similarly overstate their exports to Hong Kong but understate their exports to the Mainland. Imports are usually not understated as they are traced to the economy of origin. The result is that the Mainland understates its bilateral trade surpluses but overstates it bilateral trade deficits. Other economies trading with the Mainland similarly understate their bilateral trade surpluses but overstate their bilateral trade deficits. For instance, the true size of the USA–China bilateral trade deficit has been a perpetual source of dispute (Fung and Lau 1998). Fortunately, Hong Kong has detailed data on its entrepot trade by source and by destination. It is thus possible to construct an accurate picture of trade among the trio, and also of the trade between the CEA and the rest of the world.

Organization of the book Following this introductory chapter, Chapter 2 will analyse the opening of China and the economic integration of the China Circle. Chapter 3 will cover the policy changes among the trio that led to the reintegration of Greater Southeast China. Chapters 4 and 5 will cover respectively trade and investment between Hong Kong and the Mainland/ Guangdong. Chapter 6 will cover trade and investment between Taiwan and the Mainland/Hong Kong. Chapter 7 will give an overall view of trade and investment among the trio, correcting for the statistical biases mentioned above. Chapter 8 will cover policy issues and Chapter 9 will conclude with a discussion of the problems and prospects of the China Circle.

2 China’s Opening and the Economic Integration of the China Circle

As China’s opening is the crux to the integration of the CEA, this chapter will briefly summarize the main features of Mainland’s opening1 with special reference to the roles of Hong Kong and Taiwan. The growth and pattern of Mainland’s foreign investment and trade will be discussed, and the costs and benefits of such investment and trade analysed.

China’s opening and economic reform In the pre-reform era, China largely followed a Stalinist model of economic development that emphasized forced savings through central planning. The centrally planned economy of China was designed to insulate China’s economy from the world market so that planners could administer the domestic economy according to their priorities. To raise savings and investment and depress consumption, wages were fixed and the prices of agricultural products were set much lower than those on the world market so that peasants had little income. At the same time, the prices of manufactured consumer goods were fixed at levels much higher than on the world market to ensure that peasants could not buy much with their meagre income. The state could thus squeeze a huge surplus for investment and national defence. To preserve China’s artificial price structure, which was very different from that of the world market, planners had to insulate the domestic economy from the world market through a state monopoly in foreign trade and also through foreign exchange controls. Otherwise, Chinese enterprises would have been able to trade freely, Chinese price levels would have converged to world market levels and central planning 18

China’s Opening and the Economic Integration of the China Circle 19

would have failed. China’s exports and imports had to be centrally administered and the process was understandably inefficient. Centrally planned economies do not trade much. With their highly centralized foreign trade system, they find it difficult to participate in international commerce. Trade is reduced to a minimum. Imports are confined to indispensable goods that are not available domestically, and planners have to squeeze some commodities for exports to earn enough foreign exchange for imports. Trade is regarded as a necessary evil. In contrast, foreign trade has been the engine of growth for many newly industrializing economies (NIEs), including Hong Kong, Taiwan, Singapore and South Korea. In these economies, foreign trade is a potent channel of technology transfer. Exporters learn to master state-of-theart technology through competition in the world market. Domestic producers are forced to become efficient in order to match the standards of imports produced by efficient producers overseas. A centrally planned economy forgoes many of the benefits of trade. Domestic producers lose sight of international standards, as they do not have to compete with imports. Moreover, foreign trade is monopolized and handled by state foreign trade corporations. Producers are compelled by the state plan to deliver their products to these corporations for export. Producers thus do not have direct contact with foreign buyers. This implies that domestic producers have little chance to learn about international practices and standards. Users of imports (for example, enterprises using imported machinery) have to apply for the allocation of imports from the state and they do not have direct contacts with foreign suppliers. This implies that state foreign trade corporations may easily import the wrong equipment for the end users. In the pre-reform era, China was been able to build a huge industrial system through forced savings. Growth of per capita GNP was moderate, at around 2.0–2.5 per cent from 1957 to 1977 (World Bank 1983:10). However, as a result of a rising savings rate engineered through planning, the growth of per capita consumption was only about 1.3 per cent in the period. Despite notable improvements in public health, education and nutrition, especially for low-income groups, the Stalinist model ran into diminishing returns as a result of rising inefficiencies in investment. China’s growth was dependent on a rising savings rate. The greater part of the Chinese industrial system was highly inefficient and technologically backward. China’s opening to foreign trade and investment has been essential to China’s reform.

20


China’s opening involves the gradual abolition of the state monopoly in foreign trade through decentralizing the power to trade to a larger number of entities, including ministerial and provincial trading corporations, large enterprises and enterprises operated by foreign investors. It involves the progressive relaxation of foreign exchange controls and the freeing of the exchange rate so that market forces instead of central planning would coordinate foreign trade. It also involves the creation of an environment friendly to foreign investment through the establishment of SEZs and open areas with special privileges for foreign investors and the enactment of legislation protecting their rights. Despite setbacks, detours, and unresolved problems, China’s open policy has been extraordinarily successful. From 1979 to 2003, China’s rank as an exporter in the world jumped from the twenty-third to fourth. Inward FDI has soared from nothing to a torrent. As a recipient of FDI, China has been by far the largest among developing countries since 1992 and was second only to the USA in the world from 1993 to 1997. Though China’s rank as a host of FDI slipped from 1998 to 2001 because of the Asian financial crisis, FDI in China soared as a result of China’s entry to the WTO in late 2001, and China surpassed the USA to be the world’s number one recipient of FDI in 2002.2 As a source of FDI, China has been the largest among developing economies since 1992.3 As mentioned in Chapter 1, China’s tailored its opening towards Hong Kong, Macau and Taiwan. The opening of China coincided with the emergence of labour shortages in Hong Kong and Taiwan and the latter two economies’ need to restructure. The export-oriented, labourintensive industries of Hong Kong moved to Guangdong on a large scale, while the labour-intensive industries in Taiwan moved similarly to Guangdong and Fujian. The economic integration of the CEA started with export-oriented labour-intensive industries, and then moved to other sectors such as infrastructure and services.

Foreign investment Foreign investment, especially the investment of Hong Kong and Taiwan in the Mainland, plays a vital role in China’s opening and the economic integration of the CEA. Chinese statistics on foreign investment distinguish between ‘contracted investment’ and ‘utilized investment’. The former is better for gauging the intention to invest while the latter is a better measurement of the actual size of the investment flow. The categorization of various types of foreign capital inflow can be quite confusing, and this book adopts the following classification:


1. Loans and bonds 2. Foreign investment a. Foreign direct investment (FDI) (i) Wholly foreign-owned ventures (ii) Joint ventures (iii) Cooperative ventures (iv) Others b. Other foreign investment (i) Issuing share (ii) International lease (iii) Compensation trade (iv) Processing/assembly Loans are a form of indirect investment, as the foreign investor has no control over the enterprises involved, whereas the investor has legal control in the case of foreign direct investment (for example, equity ownership). FDI largely involves investment in the ‘three types of foreign-funded enterprises’ (sanzi qiye, namely, wholly foreign-owned ventures, joint ventures and cooperative ventures). The most important form of ‘other foreign investment’ is processing/assembly operations, or processing operations for brevity. In processing operations, Chinese firms process raw materials supplied by foreign firms for a processing fee. The processed outputs belong to the foreign firms and are exported by them. The foreign firms usually provide the required machinery, product design and technical assistance. ‘Other foreign investment’ constitutes commercial credit rather than FDI because the Chinese partner legally controls the operation and usually pays for foreign machinery and technical assistance with labour services used in making goods under contract for the foreign partner. Despite the legal distinction, the nature of ‘other foreign investment’ is similar to FDI, as foreign machinery and technology is made available for the use of the Chinese partner. Moreover, the foreign partner often has de facto control of the operation. In this book, the term ‘foreign investment’ includes both FDI and ‘other foreign investment’ but excludes loans.

Foreign capital in China Tables 2.1 and 2.2 show respectively contracted and utilized foreign capital in China. Utilized foreign loans exceeded FDI till 1991. Deng’s 1992 southern tour in support of economic reforms led to a big jump

22 Table 2.1 Contracted foreign capital in China (US$ m.) Figures in brackets are row percentages Other foreign investment

Year 1979–85 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

2000 2001 2002 2003 1979–03

Total 38 636 (100) 11 737 (100) 12 136 (100) 16 004 (100) 11 479 (100) 12 086 (100) 19 583 (100) 69 439 (100) 123 273 (100) 93 756 (100) 103 205 (100) 81 609 (100) 61 058 (100) 63 201 (100) 52 009 (100) 72 914 (100) 71 128 (100) 84 751 (100) 116 902 (100) 1 114 906 (100)

Foreign loans

Direct foreign investment

20 512 (53.09) 8 407 (71.6) 7 817 (64.4) 9 813 (61.3) 5 185 (45.2) 5 099 (42.2) 7 161 (36.6) 10 703 (15.4) 11 306 (9.2) 10 668 (11.4) 11 288 (10.9) 7 962 (9.8) 5 872 (9.6) 8 385 (13.3) 8 360 (16.1)

16 325 (42.25) 2 834 (24.1) 3 709 (30.6) 5 297 (33.1) 5 600 (48.8) 6 596 (54.6) 11 977 (61.2) 58 124 (83.7) 111 436 (90.4) 82 680 (88.2) 91 282 (88.4) 73 276 (89.8) 51 003 (83.5) 52 102 (82.4) 41 223 (79.3)

1 799 (4.66) 496 (4.2) 610 (5.0) 894 (5.6) 694 (6.0) 391 (3.2) 445 (2.3) 612 (0.88) 531 (0.43) 408 (0.44) 635 (0.62) 371 (0.45) 4 183 (6.9) 2 714 (4.3) 2 426 (4.7)

440 (1.14) 140 (1.2) 165 (1.4) 205 (1.3) 148 (1.3) 136 (1.1) 148 (0.8) 120 (0.17) 196 (0.16) 196 (0.21) 189 (0.18) 209 (0.26) 1 696 (2.8) 1 493 (2.4) 1 767 (3.4)

62 380 (85.6) 69 191 (97.3) 82 768 (97.7) 115 070 (98.4) 942 873 (84.6)

8 750 (12.0) 2 781 (3.9) 1 982 (2.3) 1 832 (1.6) 32 554 (2.9)

1 784 (2.4) 1 831 (2.6) 1 852 (2.2) 1 661 (1.4) 14 376 (1.3)

– – –

–

Sub-total

Source: China Statistical Yearbook, China Statistics Press, Beijing, various issues.

Processing operations

23 Table 2.2 Utilized foreign capital in China (US$ m.) Figures in brackets are row percentages. Other foreign investment

Year 1979–85 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

2001 2002 2003 1979–03

Total 21 790 (100) 7 258 (100) 8 452 (100) 10 226 (100) 10 059 (100) 10 289 (100) 11 554 (100) 19 202 (100) 38 960 (100) 43 213 (100) 48 133 (100) 54 804 (100) 64 408 (100) 58 558 (100) 52 659 (100) 59 356 (100) 49 673 (100) 55 011 (100) 56 140 (100) 679 745 (100)

Foreign loans 15 729 (72.18) 95 014 (69.1) 5 805 (68.7) 6 487 (63.4) 6 286 (62.5) 6 534 (63.5) 6 888 (59.6) 7 911 (41.2) 11 189 (28.7) 9 267 (21.4) 10 327 (21.5) 12 669 (23.1) 12 021 (18.7) 11 000 (18.8) 10 212 (19.4) 10 000 (16.8) – – – –

– –

Direct foreign investment

Sub-total

Processing operations

4 721 (21.67) 1 875 (25.8) 2 314 (27.4) 3 194 (31.2) 3 393 (33.7) 3 487 (33.9) 4 366 (37.8) 11 008 (57.3) 27 515 (70.6) 33 767 (78.1) 37 521 (78.0) 41 726 (76.1) 45 257 (70.3) 45 463 (77.6) 40 319 (76.6) 40 715 (68.6)

1 340 (6.15) 370 (5.1) 333 (3.9) 545 (5.3) 381 (3.8) 268 (2.6) 300 (2.6) 284 (1.5) 256 (0.66) 179 (0.41) 285 (0.59) 409 (0.75) 7 130 (11.1) 2 095 (3.6) 2 128 (4.0) 8 641 (14.6)

477 (2.19) 140 (1.9) 91 (1.1) 69 (0.67) 56 (0.56) 79 (0.77) 85 (0.74) 67 (0.35) 120 (0.31) 71 (0.16) 44 (0.09) 164 (0.30) 1 070 (1.7) 1 034 (1.8) 1 321 (2.5) 1 666 (2.8)

46 878 (94.4) 52 743 (95.9) 53 505 (95.3) 499 767 (73.5)

2 795 (5.6) 2 268 (4.1) 2 635 (4.7) 32 642 (4.8)

1 839 (3.7) 2 133 (3.9) 2 225 (4.0) 12 587 (1.9)


24


in FDI, and utilized loans were less than 20 per cent of utilized foreign capital since 1997. Our analysis focuses on FDI rather than loans for four reasons. First, loans are of decreasing importance in China’s utilization of foreign capital. Second, in comparison with foreign investment, loans represent more of an arm’s-length relationship and are less potent for technology transfer. Third, loans are not a very good indicator of the investor environment because a substantial portion of foreign loans to China are official loans, which may be given on non-economic grounds. Fourth, after the bankruptcy of the Guangdong International Trade and Investment Corporation (GITIC) in early 1998 in the midst of the Asian financial crisis, commercial loans to China dried up. Since 2000, data on foreign loans have no longer been released with the data on utilization of foreign capital. This is not a problem, as foreign loans are quite insignificant in comparison with FDI. Contracted FDI is more volatile than utilized FDI because the former is sensitive to expectations of changes in the investment environment. Utilized FDI increased steadily from the early 1980s to 1989, but stagnated from 1989 to 1990 because of the Tiananmen incident, and then jumped upwards in 1992 owing to Deng’s southern tour. Contracted FDI rose rapidly in the early 1980s to a peak in 1985, reflecting euphoria over the China market in the initial stage of China’s opening. However, the euphoria evaporated with the many problems of the Chinese investment environment, and contracted FDI tumbled in 1986. The Chinese leadership was disturbed by the reversal, and a 22point investment enticement package was announced in October 1986 (Sung 1991:56), leading to a rise in contracted FDI from 1987 onwards. Contracted FDI jumped nearly fivefold in 1992, reflecting the effect of Deng’s southern tour. The impact of the Tiananmen incident on contracted FDI was masked because it occurred in the middle of the year: the excellent record in the first half of 1989 helped to make up for the dismal performance in the second. Moreover, contracted FDI from Hong Kong and Taiwan held up despite a dramatic fall in FDI from the western countries. From 1991 to 1992, utilized FDI in China jumped from US$4.4 bn to US$11 bn, and China became by far the largest recipient of FDI among developing countries with a share of 22 per cent of the total. From 1993 to 1996, FDI in China vastly exceeded the FDI in the entire ASEAN, and China was second only to the USA in the world in inward FDI. Utilized FDI peaked at US$45 bn in 1997 and 1998, and declined to around US$40 bn in 1999 and 2000. This was partly a result of the Asian


financial crisis, and partly because the 1993 peak in contracted investment was so high (at US$111.4 bn) that it was unsustainable. Contracted FDI declined to a low of US$41 bn in 1999. Contracted FDI in China rebounded to US$63 bn in 2000, and to US$69 bn in 2001, as China was expected to enter the WTO after the signing of the bilateral Sino–US agreement in November 1999. Utilized FDI set a new record of US$46.8 bn in 2001, and rose further to US$52.7 bn in 2002, China now surpassing the USA to become the world’s number one recipient of FDI.4 Despite the sharp decline in world flows of FDI after the terrorist attack of 11 September 2001, China is expected to attract record amounts of FDI in the medium term owing to its robust economic growth and entry into the WTO in December 2001. In 2003, while utilized FDI rose only by 1.4 per cent to US$53.5 bn, contracted FDI rose by 30 per cent to a record US$115 bn, signalling a further increase in utilized FDI in the future.

China as an export base and as a market Two ideal types of investment projects can be distinguished, the first utilizing China as an export base and the second establishing a presence in China’s domestic markets. Projects of the first type tend to involve small-scale, labour-intensive manufacturing, those of the second to be large and more capital- or technology-intensive, involving manufacturing as well as services, which usually cannot be exported. Historically, Hong Kong and Taiwan invested in projects of the first type, whereas developed countries such as the USA and Japan seemingly concentrated their investment in those of the second type. With the gradual opening of China’s domestic market after Deng’s 1992 southern tour, Hong Kong and Taiwan have increasingly invested in projects of the second type as well. It happens that the two types of projects fall roughly into two different categories in China’s statistics on foreign investment. Those of the first type correspond to processing operations that are export-oriented by definition (they have to export their entire output) and tend to be labour-intensive. Those of the second correspond to foreign-invested enterprises as they can sell part of their output in the domestic market and tend to be larger in scale and more capital-intensive. However, the distinction between the two is not sharp, as many foreign-invested enterprises also process imported materials for export under contract. The bulk of exports from foreign-invested enterprises (81 per cent in 2000) are processed exports. Instead of earning a processing fee, as in

26


the case of processing operations, foreign-invested enterprises own their output and sell the processed exports for a profit. As processing operations are labour- rather than capital-intensive, their contribution to capital formation is quite small. From 1979 to 2003, according to official statistics, cumulative utilized investment in processing operations were only 1.9 per cent of foreign investment in China (Table 2.2). However, processing operations are important in China’s exports, as they are completely export-oriented. Of China’s 2003 exports, 8 per cent were exports from processing operations and 55 per cent were exports from foreign-invested enterprises. Foreign investment thus accounted for a total of 53 per cent of China’s exports. As Hong Kong and Taiwan accounted for the bulk of foreign investment in processing operations and also in exported-oriented foreign-invested enterprises, the investments from the two economies are vital to China’s spectacular export drive.

Foreign investment in China by source Tables 2.3 and 2.4 show respectively China’s contracted and utilized FDI by source from 1979 to 2003. Hong Kong is by far the largest investor, with 44 per cent of the utilized stock of FDI since 1979, while Taiwan, the USA and Japan vied for the second place with a share of around 8 per cent, and the tax haven economies or offshore financial centres (British Virgin Islands, Cayman Islands and Bermuda) are fifth with a share of 7.3 per cent. In recent years, FDI from the tax haven economies has been very significant, and this has been the second largest investment in the Mainland in contracted FDI since 1997, and in utilized FDI since 1998. For reasons explained below, such investment is likely to be Taiwanese, Hong Kong and Mainland investment in disguise. When, in 1982, China announced its intention of taking Hong Kong back in 1997, Hong Kong’s large firms tried to insure against possible nationalization by registering overseas, mostly in the tax haven economies. The Jardine group moved its registration to Bermuda in March 1984. By mid-1993, 60 per cent of all listed companies in Hong Kong had moved their registration overseas (Hook and Sung 1997:10). The result was that the offshore financial centres accounted for 60 per cent of Hong Kong’s stock of outward FDI and 44 per cent of Hong Kong’s stock of inward FDI in 2000. A substantial amount of Hong Kong’s investment in the Mainland is likely to be disguised as investment channelled from Hong Kong through the tax haven economies.

27 Table 2.3 Contracted foreign direct investment in China by source (US$ m.) Figures in brackets are row percentages.

Year 1979–85 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1979–03

National total

Hong Kong

16 325 (100) 2 834 (100) 3 709 (100) 5 297 (100) 5 600 (100) 6 596 (100) 11 977 (100) 58 124 (100) 111 436 (100) 82 680 (100) 91 282 (100) 73 276 (100) 51 003 (100) 52 102 (100) 41 223 (100) 62 380 (100) 69 191 (100) 82 768 (100) 116 901 (100) 944 704 (100)

10 799 (66.2) 1 429 (50.4) 1 947 (52.5) 3 467 (65.5) 3 160 (56.4) 3 833 (58.1) 7 215 (60.2) 40 044 (68.9) 73 939 (66.4) 46 971 (56.8) 40 996 (44.9) 28 000 (38.2) 18 222 (35.7) 17 613 (33.8) 13 329 (32.3) 16 961 (27.2) 20 686 (29.9) 25 202 (30.4) 40 708 (34.8) 414 521 (43.9)

Taiwan

n.a. n.a. n.a. n.a. 432 (7.7) 890 (13.5) 1 389 (11.6) 5 543 (9.5) 9 965 (8.9) 5 395 (6.5) 5 849 (6.4) 5 141 (7.0) 2 814 (5.5) 2 982 (5.7) 3 374 (8.2) 4 042 (6.5) 6 914 (10.0) 6 741 (8.1) 8 558 (7.3) 70 029 (7.4)

USA

Japan

1 977 (12.1) 527 (18.6) 342 (9.2) 370 (7.0) 641 (11.4) 358 (5.4) 548 (4.6) 3 121 (5.4) 6 813 (6.1) 6 010 (7.3) 7 471 (8.2) 6 920 (9.4) 4 937 (9.7) 6 484 (12.4) 6 016 (14.6) 8 001 (12.8) 75.15 (10.9) 8 156 (9.9) 10 161 (8.7) 86 368 (9.1)

1 457 (8.9) 210 (7.4) 301 (8.1) 276 (5.2) 439 (7.8) 457 (6.9) 812 (6.8) 2 173 (3.7) 2 960 (2.7) 4 440 (5.4) 7 592 (8.3) 5 130 (7.0) 3 401 (6.7) 2 749 (5.3) 2 591 (6.3) 3 681 (5.9) 5 420 (7.8) 5 298 (6.4) 7 955 (6.8) 57 342 (6.1)

* British Virgin Islands, Cayman Islands and Bermuda. Source: China Statistical Yearbook, China Statistics Press, Beijing, various issues.

Tax haven economies* – – – – – – 17 (0.1) 77 (0.1) 393 (0.4) 1 130 (1.4) 1 905 (2.1) 4 831 (6.6) 5 486 (10.8) 7 056 (13.5) 3 953 (9.6) 11 217 (18.0) 10 381 (15.0) 16 785 (20.3) 14 655 (12.5) 77 886 (8.2)

28 Table 2.4 Utilized foreign direct investment in China by source (US$ m.) Figures in brackets are row percentages.

Year 1979–85 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1979–03

National total

Hong Kong

4 721 (100) 1 875 (100) 2 314 (100) 3 194 (100) 3 393 (100) 3 487 (100) 4 366 (100) 11 008 (100) 27 515 (100) 33 767 (100) 37 521 (100) 41 726 (100) 45 257 (100) 45 463 (100) 40 319 (100) 40 715 (100) 46 878 (100) 52 743 (100) 56 140 (100) 502 402 (100)

3 134 (66.4) 1 001 (53.4) 1 588 (68.6) 2 068 (64.7) 2 037 (60.0) 1 880 (53.9) 2 405 (55.1) 7 507 (68.2) 17 275 (62.8) 19 665 (58.2) 20 060 (53.5) 20 680 (49.6) 20 632 (45.6) 18 508 (40.7) 16 363 (40.6) 15 500 (38.1) 16 717 (35.7) 17 861 (33.9) 17 700 (31.5) 222 581 (44.3)

Taiwan

n.a. n.a. n.a. n.a. 155 (4.6) 222 (6.4) 466 (10.7) 1 051 (9.5) 3 139 (11.4) 3 391 (10.0) 3 162 (8.4) 3 475 (8.3) 3 289 (7.3) 2 915 (6.4) 2 599 (6.4) 2 296 (5.6) 2 980 (6.4) 3 971 (7.5) 3 377 (6.0) 36 488 (7.3)

USA

Japan

704 (14.9) 315 (16.8) 263 (11.4) 236 (7.4) 284 (8.4) 456 (13.1) 323 (7.4) 511 (4.6) 2 063 (7.5) 2 491 (7.4) 3 083 (8.2) 3 440 (8.2) 3 239 (7.2) 3 898 (8.6) 4 216 (10.5) 4 384 (10.8) 4 433 (9.5) 5 424 (10.3) 4 199 (7.5) 43 962 (8.8)

660 (14.0) 201 (10.7) 220 (9.5) 515 (16.1) 356 (10.5) 503 (14.4) 533 (12.2) 710 (6.4) 1 324 (4.8) 2 075 (6.1) 3 108 (8.3) 3 680 (8.8) 4 326 (9.6) 3 400 (7.5) 2 973 (7.4) 2 916 (7.2) 4 348 (9.4) 4 190 (7.9) 5 054 (9.0) 41 092 (8.2)

* British Virgin Islands, Cayman Islands, and Bermuda. Source: China Statistical Yearbook, China Statistics Press, Beijing, various issues.

Tax haven economies* – – – – – – 10 (0.2) 4 (0.04) 32 (0.1) 185 (0.5) 425 (1.1) 677 (1.6) 1 981 (4.4) 4 470 (9.8) 3 123 (7.7) 4 479 (11.0) 6 109 (13.0) 8 176 (15.5) 7 041 (12.5) 36 712 (7.3)


Taiwanese companies similarly shifted their registration from Hong Kong to the offshore financial centres as insurance against possible intervention from the Mainland after the 1997 handover. Since 1997, of the holding companies formed in third territories by Taiwanese firms, 42 per cent have been in the British Virgin Islands, 22 per cent in Singapore, 20 per cent in Hong Kong and 11 per cent in the Cayman Islands (Tsai 2002:7). As mentioned before, there is substantial ‘roundtripping’ of Mainland investment via Hong Kong back to the Mainland. With the reversion of Hong Kong back to China in 1997, part of such roundtripping has allegedly been diverted from Hong Kong to the offshore financial centres as insurance against possible intervention from Beijing (Hong Kong Economic Times, 29 October 2002:A35). Five biases in Mainland statistics on FDI Mainland statistics on FDI must be taken with a grain of salt. Five caveats should be noted. First, Mainland statistics on its total inward FDI are exaggerated by the roundtripping of its own capital via offshore financial centres, Hong Kong and elsewhere. Second, Taiwan’s investment in the Mainland is grossly understated because its capital is channelled to the Mainland via third territories; for example, Hong Kong and the offshore financial centres. Investments from such third territories are correspondingly overstated. Starting in the late 1980s, the Mainland offered special privileges for Taiwanese investors surpassing those given to other investors. Taiwanese investors wishing to claim such privileges would declare their true origin and would be recorded in Mainland statistics as Taiwanese investors, despite their companies being registered in third territories. Other Taiwanese investors wishing to hide their true identity would be classified as investors from third territories. As the Mainland prepared itself to enter the WTO in the 1990s, such special privileges for Taiwanese investors were gradually phased out. Taiwanese investors would thus have less incentive to declare their true identity. Third, Taiwan’s investment in the Mainland is not only understated, but was also increasingly understated from 1996 to 2000. While Taiwanese investment in the Mainland started with small enterprises, big enterprises joined in the mid-1990s. In August 1996, Taiwan announced a ‘no haste, be patient’ policy ( jijie yongren), which tightened restrictions on large-scale investment in the Mainland. Large enterprises that breached the policy through their subsidiaries in third territories tried to hide their identity for fear of antagonising the Taiwan authorities.

30


Taiwanese investment in the Mainland thus was increasingly disguised as investment from third territories. The decline in the share of Taiwanese investment in the Mainland’s FDI from 1996 to 2000 may be entirely a statistical mirage. In the same way, the dramatic increase in Taiwanese investment in the Mainland since 2001 is likely to be exaggerated because Taiwan abandoned its ‘no haste, be patient’ policy in late 2001. Fourth, while Mainland’s inward FDI from Hong Kong is overstated by the amount of non-Hong-Kong (Mainland, Taiwanese and others) capital channelled via Hong Kong, it is understated by the amount of Hong Kong capital channelled via the offshore financial centres. The amounts of both overstatement and understatement appear to be very large. All in all, there is probably an overstatement, as Hong Kong’s investment in the Mainland appears to be too large for the size of the Hong Kong economy. Fifth, the decline of Hong Kong’s share in Mainland’s inward FDI in recent years in Mainland statistics is overstated. Hong Kong’s reversion in 1997 has diverted to the offshore financial centres investment in the Mainland previously recorded as Hong Kong’s. This includes genuine Hong Kong capital and also Mainland capital previously channelled via Hong Kong. Investment of Hong Kong and Taiwan in the Mainland According to the Mainland’s official figures, Hong Kong’s share of the Mainland’s FDI has declined from over two-thirds in 1992 to less than a third in 2003, though Hong Kong still accounted for 44 per cent of the cumulative stock of FDI since 1979. It is well known that Hong Kong’s share is exaggerated, as it includes capital intermediated through Hong Kong as well as capital originating from Hong Kong itself. It is less well known that the exaggeration is diminishing over time, as it is increasingly offset by the diversion of Hong Kong capital via the offshore financial centres to the Mainland. Hong Kong is clearly a very important source and also the foremost intermediary of direct investment to the Mainland. According to Mainland statistics, Taiwan rose rapidly to be the second investor in 1993. However, Taiwanese investment has slowed down since 1994. In terms of utilized FDI, both the USA and Japan have surpassed Taiwan since 1996, and Taiwan has slipped to the fourth place. However, as Taiwanese investment in the Mainland is grossly understated, Taiwan is most likely still the second largest investor in the Mainland. As the Taiwanese share has been increasingly understated since 1995, there may in fact be no decline in Taiwan’s share at all.


As expected, figures on contracted FDI were more volatile than utilized FDI. Contracted FDI from the USA dropped significantly in 1990 and 1991 following the Tiananmen incident, but contracted FDI from Hong Kong and Taiwan continued to rise. As Hong Kong and Taiwan together accounted for two-thirds of FDI in China, total contracted FDI in China continued to rise despite the Tiananmen incident. Hong Kong investors responded rapidly to Deng Xiaoping’s southern tour in support of economic reforms in early 1992, and Hong Kong’s share of China’s contracted FDI jumped to 69 per cent in 1992, while the shares of Taiwan, the USA and Japan declined correspondingly. Since 1993, other countries jumped onto the bandwagon, and Hong Kong’s share gradually declined. However, this decline is overstated, as mentioned above. The different reactions of Hong Kong and Taiwan investors from western investors are to be explained as follows. Investments from Hong Kong and Taiwan were more outward-oriented and they were more affected by conditions in the world market than the Chinese market. As conditions in the world market were stable in 1990 and 1991, investments from Taiwan and Hong Kong continued to rise in 1990–91. In contrast, the investments of the West were inward-oriented and they were more affected by the Chinese market, which went into a slump after the Tiananmen incident. Moreover, investors from Hong Kong and Taiwan had a better understanding of the Chinese situation. As early as 1990, they saw that China would continue with opening and economic reforms despite the Tiananmen incident, whereas Western investors were still hesitant. Lastly, the investments of Hong Kong and Taiwan were concentrated in Guangdong and Fujian, which were comparatively stable during the Tiananmen incident. According to the Mainland’s statistics, investments from outside the China Circle overtook those from within in the late 1990s. Official figures show the shares of the duo in contracted and utilized FDI declined respectively from 79 and 78 per cent in 1992 to 42 and 38 per cent in 2003 (Table 2.5). However, as mentioned above, Mainland’s statistics overstated the decline in the share of the duo. It is instructive to look at the combined share of the duo and offshore financial centres, as investments previously recorded under Hong Kong and Taiwan have been diverted to the offshore financial centres owing to the 1997 handover of Hong Kong. The combined share in the Mainland’s contracted FDI declined from 80 per cent in 1992 to 52 per cent in 1995, but stabilized at around 52 per cent from 1996 to 2000, and then rebounded to 55 per cent in 2003. The combined share in utilized FDI

32


Table 2.5 Share of Hong Kong and Taiwan (the duo) in Mainland’s inward FDI (percentages) Share of duo and tax haven economies

Share of duo

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Contracted FDI

Utilized FDI

Contracted FDI

Utilized FDI

79 75 63 50 45 41 40 41 34 40 39 42

78 74 68 62 58 63 47 47 44 42 41 38

80 76 65 52 52 52 53 50 52 55 59 55

78 74 69 63 60 57 57 55 55 55 57 50

Source: Tables 2.3 and 2.4.

declined from 78 per cent to 50 per cent in 2003. Despite the dramatic increase in investments from outside the China Circle, the Circle still accounts for half or over half of inward FDI in the Mainland in terms of the combined share.

Foreign investment in the Mainland by industry Table 2.6 shows the distribution of contracted FDI by industry. Manufacturing, real estate and other industries (mostly services, but including construction and electricity, gas and water) accounted for respectively 62, 18 and 17.5 per cent of cumulative contracted foreign capital from 1979 to 2003. The share of agriculture was less than 2 per cent. From 1979 to 1985, the share of industry was not so large (35.3 per cent), as Hong Kong’s manufacturers did not relocate to China on a large scale till 1986, when the labour shortage in Hong Kong became severe. The share of oil development was then substantial (11.5 per cent) as oil companies were attracted to China by the prospect of finding oil in the South China Sea. However, the oil strikes were disappointing and foreign capital in oil development dwindled.

Table 2.6 Contracted foreign direct investment by industry (US$ m.) Figure in brackets are row percentages. Year

Total

1979–85

16 325 (100) 2 834 (100) 3 709 (100) 5 297 (100) 5 600 (100) 6 596 (100) 11 977 (100) 58 124 (100) 111 436 (100) 82 680 (100) 91 282 (100)

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

Agriculture 294 (1.8) 62 (2.2) 125 (3.4) 209 (3.9) 121 (2.2) 122 (1.8) 220 (1.8) 678 (1.2) 1 191 (1.1) 972 (1.2) 1 736 (1.9)

Manufacturing 5 763 (35.3) 785 (27.7) 1 776 (47.9) 4 021 (75.9) 4 664 (83.3) 5 569 (84.4) 9 623 (80.3) 32 667 (56.2) 51 174 (45.9) 43 899 (53.1) 61 648 (67.5)

Oil development 1877 (11.5) n.a. n.a. 2 (0.04) n.a. 0 (0.00) n.a. 3 (0.01) 81 (0.07) 54 (0.07) 12 (0.01)

Real estate 3 053 (18.7) 1 617 (57.1) 1 471 (39.7) 530 (10.0) 524 (9.4) 452 (6.9) 1 504 (12.6) 18 080 (31.1) 43 771 (39.3) 23 862 (28.9) 17 835 (19.5)

Other industries 5 338 (32.7) 370 (13.1) 337 (9.1) 535 (10.1) 291 (5.2) 453 (6.9) 630 (5.3) 6 696 (11.5) 15 219 (13.7) 13 893 (16.8) 10 051 (11.0) 33

34

Table 2.6 Continued Year

Total

Agriculture

Manufacturing

Oil development

Real estate

Other industries

1996

73 275 (100) 51 004 (100) 52 102 (100) 41 223 (100) 62 380 (100) 69 191 (100) 82 768 (100) 115 070 (100) 942 873 (100)

1 137 (1.6) 1 065 (2.1) 1 204 (2.3) 1 472 (3.6) 1 483 (2.4) 1 762 (2.5) 1 688 (2.0) 2 280 (2.0) 17 821 (1.9)

50 486 (68.9) 27 065 (53.1) 30 827 (59.2) 25 332 (61.5) 44 254 (70.9) 48 847 (70.6) 59 270 (71.6) 80 750 (70.2) 588 420 (62.4)

13 (0.02) 22 (0.04)

12 851 (17.5) 6 222 (12.2) 6 648 (12.8) 4 178 (10.1) 5 232 (8.4) 5 031 (7.3) 7 217 (8.7) 9 110 (7.9) 168 187 (17.9)

8 788 (12.0) 16 630 (32.6) 13 423 (25.8) 10 242 (24.8) 11 410 (18.3) 13 507 (19.5) 14 523 (17.5) 22 930 (19.9) 165 266 (17.5)

1997 1998 1999 2000 2001 2002 2003 1979–03


n.a. n.a. n.a. 44 (0.1) 70 (0.1) – – 2178 (0.2)


The share of real estate fluctuated with the bubbles of the real-estate market. There was a bubble in 1986 and 1987, and the shares of real estate in contracted FDI were 57.1 per cent and 39.7 per cent respectively. The share of manufacturing was lowered correspondingly. The share of real estate fell to around 10 per cent or lower from 1988 to 1991, and the share of manufacturing rose to close to 80 per cent or above. Deng’s 1992 southern tour led to another real estate boom, and the share of real estate rose to close to 30 per cent or even above from 1992 to 1994. However, with macrostabilization starting in mid-1994, the share of real estate fell to 19.5 per cent in 1995, and has declined thereafter to around 7 to 8 per cent since 2000. The share of ‘other industries’ (mostly services) was around a third during 1979–85, largely reflecting the substantial investments in hotels. However, from 1986 to 1991, the share declined to close to 5 per cent, reflecting official policy that encouraged investment in industry. Deng’s 1992 southern tour led to gradual liberalization of services. The share of ‘other industries’ jumped to over 11 per cent in 1992, rising to a peak of close to a third in 1997, and was around 20 per cent in 2003. China’s entry into the WTO has yet to lead to a shift in contracted FDI away from manufacturing towards services because the significant liberalization in services is scheduled to take place from 2005 to 2007. By then, the share of services in FDI should increase.

China’s trade Foreign investment, especially from Hong Kong and Taiwan, has played a crucial part in China’s spectacular trade expansion. China’s share of world trade rose from 0.6 per cent in 1977 to 4.8 per cent in 2002, and China became the world’s fifth largest trader. China’s share of world trade rose faster than that of any other country in the period. Table 2.7 shows the expansion of China’s trade. Indian data are shown for comparison as the size and level of development of India is close to China’s. In 1978, the Indian economy was slightly more open than China’s: Indian exports were 5.6 per cent of its GDP, which was slightly higher than the 4.6 per cent of China. However, China’s exports expanded extremely rapidly. In 2003, China’s exports were over 35 per cent of its GDP. Though India also liberalized its economy, Indian exports were less than 10 per cent of its GDP in the same year. There has been a dramatic transformation in the commodity composition of China’s exports. Table 2.8 shows that, from 1965 to 1985, food, agricultural raw materials and mineral fuels (mainly oil) accounted for

36


Table 2.7 China’s trade since 1978 Ratio of exports to GDP (%)

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Exports (US$ m.)

Imports (US$ m.)

China

India

9 955 13 614 18 099 22 007 22 321 22 226 26 139 27 350 30 942 39 437 47 516 52 538 62 091 71 910 84 940 91 744 121 006 148 780 151 048 182 792 183 712 194 931 249 203 266 098 325 591 438 371

11 131 15 621 19 941 22 015 19 285 21 390 27 410 42 252 42 904 43 216 55 268 59 140 53 345 63 791 80 585 103 959 115 614 132 084 138 833 142 370 140 237 165 699 225 094 243 553 295 171 412 836

4.6 5.2 6.0 7.5 7.5 7.2 8.1 9.2 10.7 12.5 12.0 11.9 16.3 18.0 18.1 15.3 22.3 21.3 18.4 20.2 19.3 19.5 23.2 25.2 26.3 35.4

5.6 5.9 5.3 4.5 5.0 4.5 4.9 4.4 4.1 4.4 4.7 5.5 5.5 6.1 6.7 7.6 7.8 8.4 8.6 8.3 7.9 8.0 10.2 10.1 11.0 9.5

Source: International Monetary Fund, International Financial Statistics, International Monetary Fund, Washington, DC.

over half of China’s exports, while the share of manufactures was slightly less than half. The share of manufactures rose from 49 per cent in 1985 to 91 per cent in 2003. Among manufactures, the growth of exports of textiles and clothing was restricted by importing countries under the MFA (Multi-fibre Arrangement). The share of textile exports declined. The share of clothing exports expanded rapidly from 5 per cent in 1975 to 17 per cent in 1990, but declined to 12 per cent in 2003. The shares of footwear and toys rose rapidly in the 1980s, but stabilized in the 1990s. Electrical machinery was the fastest-growing export, and

Table 2.8 China’s export composition (percentages) Products are mostly classified by standard international trade classification (SITC); foods are groups (0 + 1 + 22 + 4); agricultural raw materials (2 less 22, 27, 28); mineral fuels (3), manufactures (5 to 8 less 68); chemicals (5); textiles (65), clothing (84), footwear (85); ores, minerals and metals (27 + 28 + 68), miscellaneous goods (9). Classification by the harmonized systems (HS) are used for toys (95) and electrical machinery (85).

All foods Agricultural raw materials Mineral fuels All manufactures Chemicals Textiles Clothing Footware Toys Electrical machinery Ores, minerals and metals Miscellaneous goods

1995

2000

2002

2003

1965

1975

1980

1985

37 11

33 7

18 6

15 7

9 3

8 2

5 1

5 1

8 1

2 46 4 14 7 – – 1

14 42 5 13 5 – – 1

22 47 6 13 9 1 0.4 1

26 49 5 13 13 1 1 2

7 80 4 12 17 5 3 11

4 84 6 9 9 4 4 13

3 88 5 6 14 4 4 18

3 90 5 6 13 3 4 20

3 91 4 6 12 3 3 20

4

3

3

3

2

2

2

2

2

–

–

4

1

1

0

0

0

0

1990

Sources: 1965 to 1975 are taken from Table 1.1 of China: Foreign Trade Reform, World Bank, 1994, Washington, DC. Other data are obtained from China Customs Statistics, Economic Information and Agency, Hong Kong.

37

38


Table 2.9 China: percentage share of FDI in gross domestic capital formation FDI

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

(US$ bn)

(RMB bn)

GDCF (RMB bn)

Ratio (%)

1.66 1.87 2.31 3.19 3.39 3.49 4.37 11.01 27.51 33.77 37.52 41.73 45.26 45.46 40.32 40.71 46.88 52.74 53.51

4.88 6.46 8.60 11.87 12.76 16.69 23.26 60.72 158.51 291.05 313.33 346.95 375.20 376.37 333.78 337.01 388.03 436.55 441.06

264.10 309.80 374.20 462.40 433.90 473.20 594.00 831.70 1298.00 1685.63 2030.05 2333.61 2515.42 2763.08 2947.55 3262.38 3681.33 4186.24 5039.66

1.85 2.08 2.30 2.57 2.94 3.53 3.92 7.30 12.21 17.27 15.43 14.87 14.92 13.62 11.32 10.33 10.54 10.43 8.75


its share rose from 1 per cent in 1980 to 20 per cent in 2003. As mentioned before, the Mainland surpassed Taiwan in 2000 as the world’s third largest producer of information technology hardware after the USA and Japan. Concomitant with the growth in exports, China’s imports also grew by leaps and bounds. China has become the world’s factory for labourintensive goods, and is also the world’s largest emergent market. China’s import liberalization has been aggressive, especially in the 1990s. The average tariff rate came down from 56 per cent in 1982 to 15 per cent in 2001. Non-tariff barriers also came down fast (Lardy 2002:39–46).

Benefits of foreign investment and trade There is no doubt that foreign trade and investment have played a crucial role in the Mainland’s rapid growth in the reform era. In 2002,


the share of trade in the Mainland’s GDP was over 50 per cent. The share of FDI in China’s gross domestic capital formation is also substantial, rising from zero in 1979 to a peak of 17.3 per cent in 1994, but declining to 9 per cent in 2003 as a result of the very rapid growth of the Mainland’s gross domestic capital formation. The share of FDI in China’s gross domestic capital formation understates the benefit of FDI to China because new technology is often embodied in FDI. According to econometric tests done on the contribution of foreign investment to growth in China in comparison with domestic investment, foreign investment appears to be much more potent than domestic investment in China’s growth (Qiu 1996; Wei 1995). Qiu’s work, the best done so far, puts the marginal product of FDI (extra output produced by one additional unit of investment) at 0.466, with the marginal product of domestic investment at only 0.165 (Qiu 1996:65). According to the above works, exports also have substantial benefits for China’s growth. It was found that exports have significant spillover effects for the non-export sector. An increase of exports by 1 per cent raises the output of the non-export sector by 0.037 per cent (Qiu 1996:58).

Summary There is no doubt that China’s opening has been very successful, and China has become a big world player in both foreign investment and trade. China is poised for another wave of opening and reform following WTO entry in late 2001. Most of China’s commitments to the WTO, especially those involving services, are scheduled to be implemented within three to six years after accession. China’s commitments are very far-reaching. As Nicholas Lardy, a renowned US expert on the Chinese economy, has observed: China’s WTO commitments, on market access and on rules-based issues, far surpass those made by founding members of the World Trade Organization and, in some cases, go beyond those made by countries that have joined the organization since its founding in 1995. Its commitments to open its services markets are especially broad and will almost certainly lead to significantly increased foreign investment in telecommunications, financial services, distribution, and various other areas. (Lardy 2002:104)

40


Hong Kong should again serve in a catalytic role in the Mainland’s new wave of opening of its highly protected services sector. In mid2003, the Mainland concluded the CEPA with Hong Kong and agreed to open the Mainland’s services to Hong Kong in early 2004, ahead of the Mainland’s commitments to the WTO. One objective of the Mainland–Hong Kong CEPA was to allow competitors from Hong Kong to stimulate the Mainland’s services providers to prepare them for the rigours of global competition. Though Hong Kong’s economy has been in crisis since 1997, Hong Kong continues to play an important role in the Mainland’s opening.

3 Policy Changes and Economic Integration

Economic integration In economic theory, economic integration means a lowering of the barriers to business between two economies. The barriers may be institutional (for example, tariffs) or natural (for example, transportation costs). In the jargon of economics, economic integration may not imply a tightly knit relationship. For instance, it has often been said that the decrease in the cost of transportation has led to global economic integration. There are three different types of institutional barriers to international economic exchange: 1. Barriers to movement of goods, such as tariffs and quotas. 2. Barriers to movement of factors of production (labour and capital), such as controls on migration. 3. Transaction costs and risks arising from the use of different currencies. Such costs are significantly higher for countries that have strict foreign exchange controls. There are also natural barriers such as geographic and cultural distances. Geographic and cultural affinities are often important in economic integration (for example, emergence of the CEA). Empirically, it has been estimated that, other things being equal, sharing a common linguistic tie is associated with a big (more than 250 per cent) increase in the bilateral FDI flow (Wei 1996:1). Many countries have entered into multilateral institutional agreements to promote economic integration. The most important among them has been the GATT (General Agreement on Tariffs and Trade), which was established after the Second World War to regulate 41

42


international trade. At the Uruguay Round of trade negotiations concluded in December 1993, member countries decided to replace the GATT with the World Trade Organization (WTO) in 1995. The WTO oversees a comprehensive set of rules governing world commerce, covering not only trade in manufactures but also in services and agricultural products, and also rules on intellectual property protection. The two most important principles of the WTO are liberalism (minimal restrictions on international transactions) and symmetry (all nations to be treated the same). Each member must observe the Most Favoured Nations (MFN) clause which stipulates that any tariff concessions made by a member to any other country must be extended to all members. This ensures the principle of symmetry and is central to the liberalization of world trade in the postwar era. The formation of trade blocs usually violates the principle of symmetry, as members of the bloc receive favourable treatment that is not enjoyed by non-members. For instance, discriminatory tariff preferences (giving tariff preferences to some members but not others) violate the MFN clause and are usually not allowed by the WTO. However, the WTO allows the formation of free-trade areas where free trade is practised among members.

Regional trading agreements The following different types of RTAs (regional trading agreements), in ascending degree of economic integration, are usually distinguished: 1. Free-trade area (FTA) – Member countries eliminate tariffs among themselves, and each member maintains its own tariff schedule on goods from outside countries. 2. Customs union – Member countries eliminate tariffs among themselves and establish common tariffs on outside goods. A customs union is a single bargaining entity in world trade. 3. Common market – Customs union plus free factor movement. 4. Economic union – Members integrate all economic policies. The above forms of trade blocs are GATTable as they are all based on the FTA. A major drawback of FTAs is the need to regulate internal trade despite the abolition of internal tariffs. Otherwise, goods from nonmembers would enter the FTA through the member with the lowest tariffs, and individual members would not be able to maintain their own tariffs for outsiders. A customs union avoids the problem by having a common external tariff, but this means that individual members lose

Policy Changes and Economic Integration 43

their autonomy in trade policies. All members must agree to a common policy and must also agree to the distribution of joint tariff revenues. The NAFTA (North American Free Trade Area) comprising Canada, Mexico, and the USA is the most prominent FTA. The European Economic Community (EEC) created by the 1957 Treaty of Rome is a common market in the process of forming an economic union. The EEC first changed its name to the European Community (EC) and then to the European Union (EU).

History of economic integration of the China Circle As mentioned before, the economies of the Mainland and Hong Kong have become highly integrated since the early 1980s. Despite the absence of official ties, economic integration has proceeded rapidly between the Mainland and Taiwan, largely utilizing the efficient intermediary services of Hong Kong. Hong Kong and South China are much more tightly integrated than Taiwan and South China as a result of both geography and Taiwan’s policy of no direct business links with China. There also is no land bridge connecting Taiwan with the Mainland. Unlike Taiwan, Hong Kong can fully exploit vertical complementarity by using trucks carrying semi-manufactures to its subsidiaries across the border. For Taiwan, investing in south China is not that different from investing in Southeast Asia in terms of labour costs, transportation costs and turnaround time, although South China has the advantage of cultural proximity.

Subregional economic integration The Hong Kong–Guangdong nexus (or Greater Hong Kong) was the first and most successful SEZ in East Asia. As East Asian countries liberalized their economies in the 1980s, numerous SEZs emerged because of geographic and market forces. Trade and investment flows grew among geographically contiguous but politically separate border areas, taking advantage of the complementarities in factor endowment and technological capacity among countries at different stages of economic development (Chia 1993). These SEZs are variously called transnational export processing zones, natural economic territories (Scalapino 1992) or growth triangles (the ASEAN term). Zones include the Tumen River area development project in Northeast Asia involving the Russian Far

44


East, Mongolia, northeast China, the Korean peninsula and Japan; the baht economic zone encompassing Thailand and the contiguous border areas of southwestern China, Burma, Laos, Cambodia and Vietnam; the Mekong River Basin Project involving the riparian countries of Thailand, Burma, Vietnam, Laos, Cambodia and southwestern China; and three growth triangles of the ASEAN: the Southern Growth Triangle involving Singapore, the Johor state in Malaysia, and Batam island in Indonesia; the proposed Northern Growth Triangle encompassing Western Indonesia, northern Malaysia and southern Thailand; and the proposed Eastern Growth Triangle involving Brunei, eastern Indonesia, the southern Philippines and Sabah and Sarawak in eastern Malaysia (Chia 1993). It must be stressed that Greater Hong Kong is a big player in world trade and investment. In 2002, Hong Kong’s re-exports of goods processed in Guangdong were US$74 bn, exceeding the exports of Thailand (US$69 bn) or India (US$50 bn). Hong Kong’s investment in Guangdong is very large. In 1995, US$8 bn of Guangdong’s US$10.2 bn of utilized FDI came from Hong Kong, exceeding total inward FDI of US$7 bn in Mexico, which was the world’s number two recipient of FDI among developing countries. The 1993 contracted FDI in Guangdong (US$33.1 bn) exceeded that in the entire ASEAN (US$17.3 bn)! In 1993, China as a whole, and Guangdong in particular, attracted so much FDI that capital inflows into the ASEAN decreased. This drop in FDI reinforced the ASEAN governments’ desire to set up the Northern and Eastern Growth Triangles to attract FDI.

Geographical proximity and cultural affinity Till the implementation of the Mainland–Hong Kong CEPA in early 2004, the vast trade and investment flows among the trio have grown without the benefits of a trade bloc. In fact, there was an obvious lack of institutional integration among the trio. Because of Taiwan’s ban on direct business deals with the Mainland, the Mainland and Taiwan are institutionally more closely integrated with most other economies than with each other. Economic integration among the trio has proceeded naturally through geographic proximity and cultural affinity rather than through institutional promotion. Besides the lack of diplomatic and commercial ties, the three important institutional barriers to economic integration most often cited are tariffs, controls on factor movements, and exchange risks. On all three counts, barriers to economic integration among the trio are very high.


For instance, take the case of the Mainland and Hong Kong. Even though Hong Kong has become a special administrative region of China in July 1997, it is specified in the Sino–British Agreement on Hong Kong that Hong Kong will remain a separate customs territory with its own currency. Migration from the Mainland to Hong Kong will be strictly controlled. In terms of barriers to movements of goods and people, Hong Kong and the Mainland are less institutionally integrated than Greece and Ireland, which are both members of the EU, which has complete freedom of movement of goods and factors between countries. Members of the EMU (the Euro zone) within the EU are even more closely integrated because of their common currency. Although economic theory concentrates on tariffs, controls on migration, and exchange integration, the effect of geographical and cultural distances may be even more important. Hong Kong is only a 30-minute train ride from China, and Taiwan also is proximate to China. The importance of cultural affinity is quite evident. People in Hong Kong had their ancestral roots in Guangdong, the primary site of Hong Kong’s investment in China. Taiwan also accounted for the bulk of investment in Fujian. These geographic and cultural proximities enable businesses to evade formal barriers to trade and investment. Tariffs can be evaded through smuggling, and there is rampant smuggling from Hong Kong and Taiwan to China. The movement of people from Hong Kong and Taiwan to China is relatively free, even though movement in the other direction is highly controlled. However, illegal immigrants from the Mainland are quite common in Hong Kong and Taiwan, as the labour markets in the two economies are extremely tight. Although the Chinese yuan is not convertible, Hong Kong currency circulates widely (and unofficially) in Guangdong, especially in the Shenzhen SEZ. The Hong Kong Monetary Authority estimated that 15 per cent to 25 per cent of the total supply of the Hong Kong currency (HK$15 to 25 bn) circulated in China (Peng and Shi 2003:6). A grey market for yuan also existed in Hong Kong for some time. The grey market became an open market in 1993, when China officially permitted visitors to move 6000 yuan out of or into China. Many Hong Kong tourist shops accept payment in yuan. By 2003, an estimated 80 billion yuan circulated in Hong Kong, and Hong Kong banks were allowed to accept offshore renminbi deposits in February 2004 as part of the Mainland–Hong Kong CEPA. After the reversion of Hong Kong to China in 1997, policy coordination between Hong Kong and the Mainland has strengthened, cumulating in the conclusion of the Mainland–Hong Kong CEPA in mid-2003. This will be analysed in detail in Chapter 8.

46


Cultural and geographical affinity versus policy change Despite cultural and geographic affinity, the integration of the trio in the cold war era was minimal. China’s reform and opening is clearly necessary to the integration of the trio. However, policy change is by no means sufficient for economic integration. The world is littered with examples of failed agreements to enhance economic integration. The reform and opening of the former Soviet Union under Gorbachev did not lead to any significant increase in FDI and in exports. The Tumen River Project involving North Korea has not yet shown significant results despite support from the Asian Development Bank. It should be stressed that policy formation does not take place in a vacuum. In China’s case, the initial policies of opening and reform instituted in 1979 could have been reversed had the results not been good. Thanks to cultural and geographic affinity, however, the opening of China led to the rapid growth of FDI, exports and GDP in Guangdong, and the results were evident in the mid-1980s. The success of Guangdong has helped to strengthen the position of the reformers in Beijing and has enabled them to push for further reforms. Reforms in China suffered a serious setback with the 1989 Tiananmen incident. The conservative leaders in Beijing were able to neutralize the repeated calls for reforms and opening from Deng Xiaoping. In early 1992, Deng went to Guangdong, where the reforms and opening policy was most successful, and he appealed to the nation to learn from Guangdong. He designated Guangdong as the ‘dragon head’ of China’s reform and opening. The role of the Hong Kong–Guangdong economic nexus in China’s policy-making is evident. It should be stressed that, as a result of cultural and geographic proximity, the dynamism of the Hong Kong economy has been able to activate market forces in China, especially in Guangdong. The growth of market forces in Guangdong and China has pressed planners towards further reform and marketization. The best example of this is the growth of the black market in foreign exchange in China. The presence of the active black market forces planners to devalue the renminbi and also to create China’s first legal market for foreign exchange in Shenzhen in 1985. The Hong Kong–Guangdong nexus also undercuts China’s foreign trade monopoly. Many localities and enterprises have been able to trade with the outside world covertly through their Hong Kong connections and China was forced to decentralize its foreign trade (Sung 1991:58–60).


Hong Kong–Mainland relations In the years since 1945, there have been three major shifts in Hong Kong’s relations with the Mainland. Before the communists came to power in China in 1949, Hong Kong was well integrated with the Mainland as both economies were capitalist. Moreover, there was free migration between Hong Kong and the Mainland. The first shift came in 1950 with the outbreak of the Korean War and the beginning of the cold war in East Asia. The Mainland–Hong Kong border was sealed and Hong Kong lost its hinterland and its entrepot trade. Hong Kong survived through an economic miracle of exportoriented industrialization, and the USA became the number one market for Hong Kong manufactures. Hong Kong grew as part of the Pax Americana instead of China, its natural hinterland. The second shift occurred in 1979 with the opening of China. Hong Kong partially regained its hinterland. Reintegration was shallow, as the Mainland’s opening was partial. While the Mainland encouraged activities that generated foreign exchange, including exports, incoming tourism and inward FDI in manufacturing, especially in export processing, it continued to restrict activities that involved the use of foreign exchange, such as imports, outward FDI and outgoing tourism. Inward FDI in services was also restricted. Besides the Mainland’s restrictions, Hong Kong has high barriers against importation of Mainland labour. Mainland labour could not come to Hong Kong, though Hong Kong capital was quite free to move into the Mainland, especially to invest in manufacturing. Hong Kong’s labour-intensive industries have largely relocated to Guangdong, and Hong Kong’s investment in the Mainland has transformed the economies both of the Mainland and of Hong Kong. However, the economic integration achieved was quite shallow as it was largely restricted to integration of the manufacturing sector. Integration of services has been slow, owing partly to the Mainland’s restrictions and partly to Hong Kong’s barriers against migration. The third shift occurred in July 1997 with the establishment of the HKSAR (Hong Kong Special Administrative Region) of China. This heralded the deep reintegration of Hong Kong with its hinterland. Deep integration was facilitated by the continual liberalization of the Mainland in the late 1990s in services, imports and outgoing tourism. The Mainland’s WTO entry in late 2001 accelerated the Mainland’s full integration with the global economy.

48


As Hong Kong is much more of a service hub than a manufacturing centre (services and manufacturing respectively accounted for 87 per cent and 5 per cent of Hong Kong’s 2002 GDP), the potential economic gains for Hong Kong from the integration of services are large. This implies deep integration as services require close personal contacts, and the integration of services is facilitated by policy coordination and the harmonization of regulatory regimes. Policy changes in the Mainland and Hong Kong in the postwar era Economic integration between Hong Kong and the Mainland is asymmetric, as Hong Kong’s economy is very open whereas the Mainland’s is relatively closed. Hong Kong is much more open to the Mainland than vice versa, though the discrepancy has narrowed significantly since the Mainland’s opening. However, the Mainland is more open to Hong Kong than to the rest of the world; for example, even in the cold war era, Hong Kong people could visit their relatives in the Mainland without a visa as they were regarded as Chinese. As mentioned before, in the early years of the open-door policy, the Mainland tailored its opening towards Hong Kong. While Hong Kong businesses had no preferential concessions in the Mainland over other overseas businesses before the implementation of the Mainland–Hong Kong CEPA in 2004, Hong Kong businesses have had a significant advantage owing to their kinship network. It must be stressed that the Mainland has been benign towards Hong Kong most of the time since the establishment of the People’s Republic in 1949. This is largely a result of Hong Kong’s traditional position as China’s ‘window’ to the outside world. Even at the height of the Cultural Revolution in the cold war era, the Mainland continued to supply potable water and foodstuffs to Hong Kong. Though Hong Kong is open to the whole world, it is less open to the Mainland than to others because of population pressure arising from kinship links. Hong Kong’s controls on migration and visitors from the Mainland have been stricter than those from other countries since 1950. Hong Kong’s controls on the entry of Mainlanders have always been an important part of its policy towards the Mainland. After Hong Kong’s reversion in 1997, Hong Kong’s controls on permanent migration from the Mainland are still very strict, though the barriers against Mainland visitors have been greatly relaxed. While the Hong Kong government generally follows noninterventionist economic policies throughout Hong Kong’s history,


Hong Kong’s policy changes towards the Mainland are nevertheless significant. In the cold war era, Hong Kong tried to keep the Mainland at arm’s length so, for instance, Hong Kong civil servants were not allowed to travel to the Mainland (and also Taiwan). The restriction was lifted only in the early 1980s. In the reform era before Hong Kong’s reversion, the Hong Kong government changed its policy from one of minimal contact to facilitating the market-driven economic integration with the Mainland. As the economic integration was largely spontaneous and market-driven, government policy was not highly pro-active. For instance, there was little coordination of infrastructure between Hong Kong and Guangdong. Since the reversion, Hong Kong’s policy has changed to one of proactive coordination, cumulating in the conclusion of the CEPA with the Mainland.

The first shift: Hong Kong’s estrangement from the Mainland Before the communists came to power in 1949, Hong Kong had been an important entrepot for China. China could have taken Hong Kong by force in 1949, but Beijing chose to leave Hong Kong in British hands. This suggested that Beijing placed a high value on the role of Hong Kong as China’s window to the outside world. Following China’s entry into the Korean War in 1951, the United Nations embargoed sales of strategic materials on China, and the USA banned all imports from China. Strategic materials were smuggled from Hong Kong into the Mainland on a large scale despite the interdiction of the Hong Kong government. Owing to China’s isolation, the value of Hong Kong as China’s window to the world was enhanced. Hong Kong’s entrepot trade nevertheless withered, partly as a result of the UN embargo and US ban and partly because Beijing centralized international trade in the hands of the state and redirected China’s trade to the Soviet bloc. The greater part of the Mainland’s trade in the 1950s was state-to-state trade handled directly by the government’s foreign trade corporations, bypassing Hong Kong. The Mainland’s imports from Hong Kong dwindled to negligible amounts. The Mainland’s exports to Hong Kong continued to grow owing to the Mainland’s need to earn hard currency, particularly after the Sino–Soviet rift of the late 1950s. With the withering of entrepot trade, Hong Kong was deprived of its main means of livelihood. However, refugee capital and labour from the Mainland transformed Hong Kong into an industrial city and a dazzling

50


example of success through an export-oriented strategy. Hong Kong became a lucrative market and the Mainland’s exports to Hong Kong grew rapidly in the 1960s and 1970s. In the 1960s, Hong Kong was the foremost market for the Mainland. The Mainland’s trade surplus with Hong Kong was around one-fifth of its total exports, and the Mainland used the hard currency thus earned to finance imports of grain, industrial raw materials and capital goods from developed countries. As China was isolated, it invested heavily in Hong Kong in order to use Hong Kong as China’s window to the world. However, the Mainland accepted very little investment from Hong Kong or elsewhere, and imported very little from Hong Kong. To stem the heavy influx of migrants from the Mainland, the Hong Kong government instituted increasingly severe border controls. With the outbreak of the Korean War in 1950, the Mainland–Hong Kong border was sealed and the rail link with Guangzhou severed. The Hong Kong government issued identity cards to the local population to distinguish between residents and non-residents, and Hong Kong residents visiting the Mainland had to produce identity documents on their return. The Mainland also instituted tight exit controls from early 1951. Hong Kong, however, continued to accept Mainlanders who were allowed by the Mainland to migrate to Hong Kong. Because of close family ties between Hong Kong and the Mainland, the number of legal migrants could be quite large, reaching 310 per day at the end of 1978. Moreover, large numbers of illegal migrants continued to enter after 1950 and were allowed to stay. As a result, Hong Kong enjoyed a steady supply of labour for its export-oriented, labour-intensive industries. The peculiarity of Hong Kong’s export-oriented industrialization was that Hong Kong was partially cut off from its hinterland, though it continued to enjoy a steady supply of food and potable water from the hinterland. Hong Kong also obtained enough labour for its labour-intensive industries from refugees. Compared with regular migrants from the hinterland, refugees adapted to industrial discipline much faster because they had their backs to the wall and could not go home. They made much better industrial workers. Hong Kong was spared the many problems of rural migration and return migration; namely, unemployment, high labour turnover, sanitation and contagious diseases. In a nutshell, Hong Kong could take most of the blessings of its hinterland without many of the curses.


The second shift: China’s opening and shallow reintegration Before China’s opening, the economic relationship between Hong Kong and the Mainland was asymmetric. Hong Kong was open to China’s exports and investment, and Hong Kong residents were able to visit their relatives in China, but reverse flows were largely barred. With the inauguration of China’s economic reforms and open policy in 1978, the economic relationship between the Mainland and Hong Kong became more balanced and multi-faceted, and Hong Kong’s exports and outward FDI to the Mainland soared rapidly. As mentioned before, China’s initial opening was partial and its integration with the world economy was quite shallow. Despite dramatic growth of China’s exports and inward FDI, China’s controls on the use of foreign exchange (imports, outward FDI and outgoing tourism) continued to be quite strict. Import duties and restrictions remained high until the mid-1990s. A notable exception was that materials used in export processing could be imported tariff-free to encourage exports. Such tariff-free imports of materials and equipment for export processing accounted for as much as one-half of China’s imports in the mid-1990s. This shows that China’s barriers to imports were quite high. Mainland’s shallow integration with Hong Kong started with export processing and later spread to other sectors. Owing to Hong Kong’s traditional position as China’s window to the outside world, it is not surprising that China tailored its open-door policy to forge closer links with Hong Kong. China allowed Guangdong to experiment with economic reforms and established SEZs to forge links with Hong Kong. On paper, Hong Kong businesses receive no preferential concessions in China over other overseas businesses. In reality, owing to geographical proximity and kinship links, Hong Kong businesses have a significant advantage. Hong Kong investors have been able to obtain favourable concessions from local authorities in Guangdong as a result of the kinship network. The loosening of social controls in the Mainland after the death of Mao Zedong in 1976 led to an influx of over 0.5 million legal and illegal immigrants into Hong Kong from 1976 to 1980. In 1980 alone, there were 200 000 illegal immigrants. As a result of the rapid rise in income in Hong Kong and the improvement of social services and social welfare, unskilled immigrants were regarded as a liability rather than an asset. Moreover, unlike the refugees of the 1950s, the illegal immigrants of the

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late 1970s were looking for better economic opportunities instead of fleeing from political problems. There was little public sympathy for the illegal migrants. The Hong Kong government tightened controls against illegal immigrants in late 1980, and instituted a system of computerized identity cards, which residents had to carry in public places. Illegal immigrants who were caught were promptly repatriated to China. According to the treaties that ceded Hong Kong to Britain, Chinese had the right to enter Hong Kong and the Hong Kong government could not refuse their entry. However, to alleviate population pressure in Hong Kong, the Mainland agreed to an exit quota of 150 legal migrants per day in 1980. The quota was subsequently lowered to 75 per day in 1982. As a result of Hong Kong’s tight controls against illegal immigrants and China’s exit quota, the labour market in Hong Kong became very tight from 1986 onwards. From 1987 to 1994, the annual unemployment rate in Hong Kong never rose above 2 per cent. With the rapid rise in wages in Hong Kong in the late 1980s, the human capital that Hong Kong manufacturers had accumulated in the production and export of labour-intensive products would have been obsolete if Hong Kong firms did not relocate to economies that still had abundant labour. However, most manufacturing firms in Hong Kong are small and they are ill equipped to operate across geographic and cultural barriers. The Mainland has the advantage of geographic and cultural proximity and its opening presented a golden opportunity to Hong Kong manufacturing firms, which relocated to the Mainland in droves. The main destination of Hong Kong manufacturing firms is Guangdong province, which has the advantage of geographic and cultural proximity. Guangdong accounted for around 40 per cent of Hong Kong’s FDI in China and around 30 per cent of all FDI in China. To deal with the labour shortage, the Hong Kong government embarked on a labour importation scheme in 1989. The third labour importation scheme, announced in January of 1992, doubled the labour intake quota to 25 000, practically all of which was to be filled by workers from China. However, the quota was slashed to 1000 in 1995 because of rising unemployment in Hong Kong. Importation of unskilled workers from the Mainland has not been substantial, owing to opposition from unions in Hong Kong. Blessings of reintegration The successful reintegration of Hong Kong with its hinterland brought prosperity to both Hong Kong and China, and this prosperity quickly


overcame the gloom following the Tiananmen incident of 1989. The net emigration of permanent Hong Kong residents reached a peak of 48 100 people in 1990, but declined to 38 900 and 24 100 respectively in 1991 and 1992. The successful economic development in Guangdong has strengthened the reformers in China. Deng Xiaoping toured Guangdong early in 1992 and designated Guangdong the ‘dragon head’ of China’s economic reforms. Investors in Hong Kong responded immediately to the change. Hong Kong’s contracted FDI in China jumped from US$7 bn in 1991 to US$40 bn in 1992, and jumped again to US$74 bn in 1993. Hong Kong’s net emigration of permanent Hong Kong residents also turned abruptly into net immigration of 1100 people in 1993, increasing rapidly to net immigration of 63 900 people in 1996. The 1996 population of Hong Kong was 407 000 above that projected by the Hong Kong government in 1992, largely because of the sudden influx of returning migrants. Hong Kong’s investment in Guangdong transformed both economies. Hong Kong manufacturing firms reportedly employed up to 11 million workers in Guangdong in 2001, while the manufacturing labour force in Hong Kong fell from a record of 919 000 in 1987 to 307 800 in 1997, and fell further to 193 500 in 2002. Unemployment remained low as redundant manufacturing workers found jobs rapidly in the expanding services sector as the industrial base in the PRD was serviced from Hong Kong. By moving the labour-intensive processes to Guangdong, Hong Kong can concentrate on the more skill-intensive processes such as product design, sourcing, production management, quality control and marketing. The expansion of exports from processing operations in Guangdong also increased the demand for Hong Kong’s service industries, including entrepot trade, shipping, insurance, business services and financial services. Guangdong was highly dependent on Hong Kong for skilled as well as less-skilled services because the Mainland’s services sector was underdeveloped owing to the traditional Marxist bias that services were ‘unproductive’. Even unskilled manufacturing workers in Hong Kong were able to find work in less-skilled services. Hong Kong was transformed into the service hub of an industrialized Guangdong. The structural transformation was exceedingly smooth and benign. From 1987 to 1994, the unemployment rate in Hong Kong was consistently below 2.5 per cent.

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The third shift: deep integration after 1997 While the Mainland’s integration with the world economy was quite shallow in the early years of its open-door era, China continued to liberalize its restrictions on the use of foreign exchange (imports, outward FDI and outgoing tourism) in the 1990s. By the late 1990s, China had the lowest tariff protection of any developing country (Lardy 2002:9). Besides lowering tariffs and import restrictions, China also gradually allowed outgoing tourism and outward FDI, and also inward FDI in services. As services tend to be non-tradable, the usual way to ‘import’ services is to allow provision of services by a foreign firm through inward FDI. China’s entry to the WTO in late 2001 accelerated China’s movement towards full integration with the global economy. In fact, as Nicholas Lardy observed: China’s market access and other commitments are not only more farreaching than those that governed the accession of countries only a decade ago, they exceed those made by any member that has joined the World Trade Organization since 1995. (Lardy 2002:10) Both Hong Kong and the Mainland had strong incentives to promote deep integration after 1997. Hong Kong tried to leverage on its Mainland connections to recover from the economic crisis that occurred after reversion. Politically, the Mainland wants to keep Hong Kong’s economy healthy to demonstrate the viability of ‘one country, two systems’, as the formula is also intended for Taiwan. Moreover, the reversion of Hong Kong in 1997 more or less coincided with the Mainland’s plan to accelerate the liberalization of its foreign trade and investment regime, as evidenced by the Mainland’s many reforms in preparation for WTO entry in the late 1990s. Hong Kong is a good testing ground for the Mainland’s programme of eventual deep integration with the global economy, which was spelled out clearly at the time of China’s WTO entry in late 2001. Prelude to deep integration The adjustments to Hong Kong’s reversion in 1997 had occurred well before 1997 because the handover was known 14 years in advance with the signing of the Sino–British Declaration in 1984. For instance, Mainland investors had stepped up their investment in Hong Kong since 1984 because they considered Hong Kong their future turf. Hong Kong


capitalists could acquire goodwill by investing in China, or helping Chinese companies to invest in Hong Kong. Many Hong Kong firms have acquired useful Chinese connections through such investments, and they have been well positioned to take advantage of the gradual liberalization of services in China since the 1990s. As services are performed for people, cultural and geographic proximities are even more important than in goods production. Given Hong Kong’s comparative advantage in services, the liberalization of services in China should bring tremendous benefits to Hong Kong. Since the mid-1990s, Hutchison Whampoa has invested in most of the ports in GSC, stretching from Shanghai southwards to the Pearl River Delta. Many Hong Kong banks have also entered the Chinese market. Hong Kong’s industrial base in Guangdong fed the growth of Hong Kong’s service providers, and some of them developed into global players; for example, HSBC (Hong Kong Shanghai Banking Corpn) in banking, Hutchison Whampoa in container ports and mobile networks, and PCCW (Pacific Century Cyber Works) in telecommunications. They have the capability of competing with multinationals in the Mainland’s service markets. The process of deep integration Hong Kong’s restoration to China has facilitated the process of integration. With the Sino–British disputes out of the way, Hong Kong and the Mainland found it easier to coordinate infrastructural developments and economic policies. Policy coordination is especially important in integration of services because services, for example banking, insurance, and telecommunications, are often highly regulated. However, deep integration involves changes on many fronts in both Hong Kong and the Mainland and the process was far from smooth. In the first few years after Hong Kong’s reversion, the elites in Hong Kong were hesitant about deep integration with the Mainland because of concerns about the possible adverse impacts on Hong Kong’s autonomy and international image. Consensus on the necessity of deep integration was reached only in late 2002 with the worsening economic crisis. The Mainland was extremely careful in liberalizing its capital account controls because the Asian financial crisis highlighted the dangers of capital account convertibility. In the first five years of Hong Kong’s reversion, not much was accomplished in terms of deep integration with the Mainland. A confluence of events accelerated the pace of coordination in 2003. From early 2003 onwards, the USA led a new round of international calls on China to appreciate its currency as the US bilateral trade deficit

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with China continued to soar and China continued to have persistent surpluses in both the current and capital accounts. China’s foreign exchange reserves swelled to US$346.5 bn in mid-2003. Though China is unlikely to appreciate its currency in the short term, it is clearly desirable for China to relax its controls on the use of foreign exchange. The economic crisis in Hong Kong caused by SARS in early 2003 and the popular dissatisfaction with the Hong Kong government spurred the Mainland to act decisively. The Mainland–Hong Kong CEPA was signed in mid-2003. Starting late July 2003, Mainlanders were allowed to tour Hong Kong individually, and the measure is expected to bring 4 million additional tourists to Hong Kong every year. In November 2003, an agreement was signed between Hong Kong and the Mainland to allow offshore renminbi business in Hong Kong. Plans to allow overseas portfolio investment in Hong Kong by Mainlanders through the QDII (Qualified Domestic Investment Institution) Scheme received renewed attention. These and other measures to further integration will be covered in detail in Chapter 8. Curses and blessings of the hinterland For Hong Kong, the process of deep integration with its hinterland is not without pain. The hinterland supplies food, labour, markets and business opportunities for the metropolis. The hinterland may also be a reservoir of backwardness, contagious diseases, poverty, population pressure and illiteracy. Before 1997, Hong Kong had been able to maintain high barriers against Mainland migrants, and thus to avoid the massive immigration and unemployment that is typical in many Third World cities. In its relations with the hinterland, it was therefore able to take most of the blessings and to avoid the greater part of the curses. However, since 1997, despite continuing stringent restrictions, Hong Kong inevitably has had to accept more migrants from the Mainland and with them some of the curses along with the blessings. As a wage gap of more than ten to one had emerged between Hong Kong and Guangdong during the cold war, reintegration implied rapid structural change and structural unemployment. Before 1997, structural unemployment was not a big problem as employment in services was expanding rapidly, owing partly to a booming economy and partly to Hong Kong’s temporary monopoly in services. Hong Kong’s economic bubble burst in the autumn of 1997 because of the AFC (Asian financial crisis). Moreover, its temporary monopoly in services was eroded by the rapid development of services in the Mainland, Hong Kong service providers having had to compete with the Mainland’s on quality. The


unemployment rate in Hong Kong rose from 2.2 per cent in mid-1997 to a high of 8.7 per cent in August 2003. Besides painful structural change, Hong Kong has had to accept more migrants from the Mainland since reversion, because Hong Kong residents have large numbers of family members in the Mainland, and many of them have the right of abode in Hong Kong according to the Basic Law (the mini-constitution of the HKSAR). According to a government survey in 1999, Hong Kong residents have 791 300 children in the Mainland (including 505 000 born outside wedlock), of whom around one-third or 267 600 (including 170 000 born outside wedlock) have the right of abode in Hong Kong according to the Basic Law; that is, at the time of the child’s birth, at least one of the parents had already acquired permanent residence in Hong Kong. Two-thirds of the children of Hong Kong residents in the Mainland do not have the right of abode in Hong Kong as they were born when neither parent had yet acquired permanent residence in Hong Kong. With the establishment of China’s exit quota in 1982, Hong Kong residents’ children in the Mainland have had to wait for many years to migrate to Hong Kong. To clear the backlog, the Mainland raised the exit quota with the agreement of the Hong Kong government from 75 per day to 105 per day in 1993 and then to 150 per day in 1995. The quota is further divided among Hong Kong residents’ children who have the right of abode in Hong Kong (subquota of 60), spouses separated for more than 10 years (subquota of 30) and other applicants (subquota of 60), such as spouses separated for less than 10 years, or Hong Kong residents’ children who do not have the right of abode in Hong Kong. The quota of 150 per day amounts to 54 760 immigrants per year, and this alone implies a population growth of around 0.8 per cent per year. New immigrants from the Mainland accounted for 93 per cent of Hong Kong’s population growth from 1997 to 2001, as the fertility rate in Hong Kong is among the lowest in the world (see below). Because of Mainland’s exit quota on migration to Hong Kong, migration to Hong Kong from the Mainland for family reunion usually involves a long wait, while migration from other countries to Hong Kong for family reunion is much faster. Though most of the children of Hong Kong residents in the Mainland who have the right of abode in Hong Kong had already migrated by 2003, owing to the increase in the exit quota in 1995, new applications would still take a couple of years. The migration of spouses usually takes up to eight years.

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Hong Kong’s population policy The importance of immigration prompted the Hong Kong government to propose a population policy in February 2003 (HKSAR Government 2003). As Hong Kong’s population is ageing rapidly, the migration of the young children of Hong Kong residents into Hong Kong can be a blessing. Hong Kong’s total fertility rate reached an extremely low level of 927 children per 1000 women in 2001, well below the replacement level of 2100 children per 1000 women. The immigration of young children rejuvenates Hong Kong’s ageing population, which is necessary for long-term growth. It is in Hong Kong’s interest to allow these children to migrate to Hong Kong early, to receive education in Hong Kong and facilitate their assimilation. Adult immigrants from the Mainland are significantly less educated than the local population and their migration has an adverse impact on growth. A previous study estimated that the immigration of low-skilled Mainlanders lowered the growth rate of Hong Kong in the mid-1990s by nearly 1 per cent per year (Sung and Wong 2000:221). The estimate is likely to be biased upwards as it did not take into account the fact that immigrants usually are more motivated to work and learn than local workers. As a result, many studies found that immigrants can be absorbed in the long run without much difficulty (Lam and Liu 1998:91). The government’s population policy proposed to provide effective training opportunities for adult migrants from the Mainland. To limit the welfare entitlements of new immigrants, the government has decided that new immigrants will not be entitled to welfare and medical benefits till they have become permanent residents after residing in Hong Kong for seven years.1 Complete integration in the long run? With economic integration between Hong Kong and the Mainland, cross-border marriages are increasingly popular. The share of crossborder marriages among newlyweds in Hong Kong has risen from 10.6 per cent in 2000 to 33.4 per cent in the first seven months of 2003 (Ming Pao, 2 September 2003:A03). In terms of policy, it is easier to correct for skill deficits than to encourage births to rejuvenate an ageing population. The availability of cross-border marriages may be more of an asset than a liability. In the very long run, the increase in cross-border marriages will change Hong Kong society in fundamental ways, leading to the complete integration of Hong Kong with the Mainland.


The ultimate solution to Hong Kong’s population pressure lies in deep integration with the Mainland. By facilitating border crossings, the government can encourage Hong Kong residents to live in Shenzhen and commute to Hong Kong to work. When living standards in Shenzhen and Hong Kong converge, ‘one country, one system’ may be the natural outcome.

Labour market integration As mentioned before, Hong Kong’s barriers to importing Mainland labour are very high. However, owing to the global competition for talents, Hong Kong’s barriers against importing professionals from the Mainland have been gradually relaxed. Since 1990, Hong Kong employers have been permitted to employ Mainland professionals who have stayed overseas for over two years. In April 1994, the Hong Kong government announced a trial scheme to import 1000 Mainland graduates. The scheme has not been very successful, being quite cumbersome owing to over-regulation on the Hong Kong side. Starting at the end of 1999, Hong Kong allowed the importation of Mainland talents (and their family members) for innovation and research without quota. Up to the end of 2002, there were only 256 successful applications in the Admissions of Talents Scheme, partly because the manpower requirements for top-notch talents for ‘innovation and research’ may not be very large. In early June 2001, Hong Kong launched a scheme to allow importation of Mainland professionals without quota. However, the scheme was restricted to personnel in financial services and information technology. Unlike professionals from other countries, those from the Mainland were not allowed to bring their spouses and dependent children. As a result of these restrictions, there were only 268 successful applications by the end of 2002, one and a half years after implementation of the scheme. This compared with an average of about 16 700 professionals per year from other countries coming to Hong Kong to work between 1997 and 2001. Hong Kong’s restrictions against Mainland professionals were obviously too tight. On 15 July 2003, Hong Kong replaced the above two schemes with a new Admission Scheme for Mainland Talents and Professionals to bring the conditions for admission for Mainland professionals in line with those from elsewhere. For instance, the sectoral restriction for Mainland professionals was lifted, and Mainland professionals would be allowed to bring their spouses and dependent

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children. The new scheme led to an upsurge in the inflow of Mainland professionals. By the end of 2003, five and a half months after implementation of the new scheme, there were 1350 successful applications. Mainland students graduating in Hong Kong universities from 1990 onwards can seek employment in Hong Kong. In 2003, the government increased the quota of non-local undergraduates from 2 to 4 per cent of the publicly funded student places in Hong Kong. The quota for nonlocal graduate students was abolished to attract more students from the Mainland. It should be noted that there are few restrictions against Mainlanders entering Hong Kong on official passports, and it is estimated that by March 1994, 65 600 Mainland cadres were working in Mainland companies in Hong Kong (Lin and Kan 1996:131). While Hong Kong has high barriers against the importation of unskilled Mainland workers, Mainlanders migrating to Hong Kong for family reunion are mostly unskilled. Mainland migrants contributed to around 30 per cent of the growth of Hong Kong’s labour force between the end of 1999 and the end of 2001, and their arrival has exacerbated the difficulties of unskilled local workers who are already suffering from the structural transformation of the Hong Kong economy towards higher value-added services. There are also a substantial but unknown number of illegal immigrants from the Mainland working in Hong Kong. The problem has become more serious with the dramatic increase in Mainland tourists. In 2002, tourists from the Mainland grew by 53 per cent to 6.8 million, or 41 per cent of total tourist arrivals. In 2003, Hong Kong’s immigration department arrested 16 548 illegal workers, an increase of 37 per cent over 2002. Given the large wage differential between Hong Kong and the Mainland, Hong Kong has inevitably to be prepared for the problems of population pressure, unemployment and income maldistribution, which are endemic in many third world cities. These problems can only be solved in the long run by economic development of the Mainland. In the transition, Hong Kong has to manage the problems through judicious border control and coordination with the Mainland; for example, the coordination to fight cross-border crime has been quite effective. Hong Kong has been replacing the identity cards of all residents with smart cards since August 2003. This will alleviate border congestion and also help to stem illegal immigration.


Mainland–Taiwan relations Mainland–Taiwan relations have a long history that goes back to the civil war between the communist and the nationalist parties in China that began in 1926. In the interest of brevity, this book will concentrate on economic aspects of the relationship, though the changes in economic relations have often been caused by political events. With China’s entry into the Korean War in 1951, the Chinese civil war became part of the cold war. During the cold war era, Mainland– Taiwan economic exchanges were all but non-existent. Taiwan, however, purchased the Mainland’s herbal medicine indirectly via Hong Kong through officially approved importers, since the herbs could not be grown on Taiwan. With the inauguration of economic reforms and the open-door policy in China in December 1978, Beijing called for the establishment of ‘three links’ (mail, travel and trade) ‘and four exchanges’ (science, culture, sports and arts) with Taiwan on New Year’s Day, 1979. On the same day, the USA established diplomatic relations with the Mainland and broke off its long-standing diplomatic relations with Taiwan. Faced with diplomatic isolation, Taiwan nevertheless adhered to its original schedule of liberalization and lifted its ban on overseas travel for tourist purposes on the same day. Though Taiwan responded to Beijing’s overture with a reaffirmation of the old ‘three noes policy’ (no contact, no negotiations and no compromise), Taiwan’s relaxation of tourist travel constituted a ‘known loophole’ in the policy of no contact. Taiwanese can meet their Mainland relatives in third countries or even secretly visit their relatives on the Mainland through Hong Kong or other places. Before November 1987, when the ban on travel to the Mainland was lifted, around 10 000 Taiwanese secretly visited the Mainland every year (Wakabayashi 1990:6). On 30 September 1981, Ye Jianying, chairman of the Standing Committee of the National People’s Congress, announced the famous ‘Nine-Point Proposal’ calling for peaceful reunification through negotiation, allowing Taiwan to maintain its capitalist system and army. Taiwan would enjoy a high degree of autonomy as a ‘Special Administrative Region’ of China. In January 1982, Deng Xiaoping announced that the formula of ‘one country, two systems’ would apply to Taiwan as well as Hong Kong. Taiwan responded with a reiteration of its ‘three noes’. Though Taiwan gradually sanctions indirect trade and investment with the Mainland, Taiwan rejects ‘one country, two systems’ as it

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requires the submission of Taipei as a provincial government to the central government in Beijing. The Mainland attempt to bring Taiwan into the fold consists of a three-prong strategy (Kemenade 1998:112): 1. Encourage Taiwanese businesses to invest in and trade with the Mainland. 2. Increase pressure to undermine Taiwan’s residual international position. 3. Threaten military force as a last resort against Taiwan’s move towards independence. Taiwan countermeasures include restrictions on investment in and trade with the Mainland; ‘dollar diplomacy’ to buy recognition from impoverished, small countries; cultivation of unofficial yet substantial relations with western countries; and purchase of advanced weapons, mainly from the USA.

Taiwan’s policy changes and interactions with the Mainland Taiwan’s export-oriented growth since 1960 has been very successful. Like Hong Kong, Taiwan has accumulated valuable human capital in the export of labour-intensive products. This knowledge has had increasing returns and has fed an explosive growth process, leading to persistent trade surpluses in the 1970s. These surpluses increased dramatically in the early 1980s with the appreciation of the US dollar under Reagan. Taiwan’s current account surplus reached 20 per cent of the GNP in 1986 (Naughton 1997:86–7). To cope with this huge disequilibrium, Taiwan should have revalued its currency, and also relaxed its foreign exchange controls to promote outward foreign investment. However, the government was wary of hurting the interests of export-dependent manufacturers and refused to revalue. It delayed adjustment by building up huge foreign exchange reserves, which represented ‘foreign investment’ by government. This led to the diversion of resources into low-yielding assets and also generated trade frictions with the USA. Moreover, Taiwan’s domestic investment declined as investors were expecting a revaluation, which would have meant cheaper imported equipment. The situation became more and more untenable (Naughton 1997:88–9). Revaluation was finally forced on the government in 1986 by the USA and also by the logic of the situation. Taiwan’s currency was revalued


by 40 per cent against the US dollar in two years. Foreign exchange controls were relaxed in July 1987, partly in response to US pressure, and indirect investment on the Mainland grew rapidly. In November 1987, Taiwan lifted the ban on visiting relatives on the Mainland, a landmark decision in Taiwan’s Mainland policy. In October 1989, Taiwan promulgated regulations sanctioning indirect trade, investment and technical cooperation with China. The Mainland’s opening eased the adjustment process for Taiwan. Were it not for the opportunity to invest in the Mainland, revaluation would have implied the obsolescence of Taiwan’s human capital in the production and exporting of labour-intensive products. It happens that Taiwan’s liberalization and rapprochement with the Mainland coincided with the third wave of the opening of China in 1987–8, under the ‘Coastal Development Strategy’. Before 1987, China had tried to attract high-tech investment and also to increase domestic content and backward linkages. Labour-intensive and low-tech investment was not welcome, except in Guangdong, where provincial policies have been more pragmatic. This implies that the pace of foreign investment in China was not very high, apart from in Guangdong. The Coastal Development Strategy was launched by Zhao Ziyang, and accepted low-tech, labour-intensive processing operations geared for exports. Preferential policies for foreign investors were strengthened. Fully foreign-owned ventures, severely restricted before 1987, became much more common. This was important for Taiwanese investors, who have a preference for fully foreign-owned ventures (Naughton 1997:91–2). A 1988 State Council decree gave Taiwanese investors favourable treatment over other foreign investors (Sung 1992:8). Local authorities also tend to give Taiwanese investors more favourable treatment in terms of a faster approval process or better support services. China later abolished the special favours for Taiwanese and overseas Chinese investors as part of the reform package to gain entry into the WTO. However, Hong Kong residents and Taiwanese will continue to enjoy simpler border formalities and probably special informal treatment from local authorities in Guangdong and in Fujian.

Framework governing Taiwan–Mainland interactions Though the Mainland is more open to Taiwan than to any other economy, Taiwan is less open to the Mainland than to other economies.

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Taiwan still bans direct business links with China, though what constitutes ‘direct’ here has been gradually softened and reinterpreted. On 23 February 1991, Taiwan promulgated a policy on national reunification. Taiwan would abandon its policy of ‘three noes’ and establish official contacts with the Mainland on the condition that the Mainland would soften its drive to isolate Taiwan diplomatically and abandon the threat to use force against Taiwan. In the absence of these friendly gestures, Taiwan would continue to shun official contacts with the Mainland. However, Taiwan would gradually develop its unofficial exchanges with the Mainland. Bilateral issues would be dealt with by the Straits Exchange Foundation (SEF), a semi-official body established by Taipei. On 1 May 1991, Taiwan officially terminated the ‘period of communist rebellion’ on the Mainland, declaring an end to the four decades of civil war across the Taiwan Strait. This action enabled Taiwan to adopt a more pragmatic policy towards the Mainland. At the same time, a delegation from the Straits Foundation visited Beijing for the first time and requested cooperation in solving problems such as privacy in the Taiwan Strait and illegal immigrants entering Taiwan from the Mainland. Beijing responded to Taiwan’s moves. In December 1991, the Mainland established the ‘Association for Relations Across the Taiwan Strait’ (ARATS) for dialogue with Taiwan. Both sides agreed to hold a nonpolitical summit between the heads of the two organizations. Wang Daohan of ARATS met with Koo Chen-fu of SEF in April 1993 in Singapore. Wang Daohan had been the mentor of President Jiang Zemin, who succeeded Wang as mayor of Shanghai before his promotion to Beijing. Koo Chen-fu had been Taiwan’s ambassador-at-large and also the confidant of President Lee Teng-hui. These high-level ‘Wang–Koo’ talks only reached accords on mundane matters such as the verification of documents, compensation for lost registered mail and agreement to seek regular contacts in the future. However, both sides appeared to agree to a ‘one China’ policy, though its interpretation was as different as ever.

Development of Taiwan–Mainland economic links in the 1990s In accordance with its conciliatory attitude in the open-door era, Beijing took steps to promote exchanges with Taiwan in 1980, including sending a mission to Hong Kong to buy Taiwanese goods to the value of US$80 m. Mainland imports from Taiwan in 1980 jumped to 11.5 times that of 1979. China also abolished the tariff on Taiwanese goods in 1980 on the grounds that Taiwan was a part of China, and import


approvals for Taiwanese goods were given priority over those for other goods. China’s import of Taiwanese goods rose so rapidly that Taiwan’s stocks were short and China imported a lot of defective products. China also imported a lot of Hong Kong goods with fake Taiwanese documents. To rectify the chaos, Beijing levied ‘adjustment taxes’ on Taiwanese goods in May 1981, though Taiwanese goods still had an advantage, as the adjustment taxes were slightly lower than tariffs. Taiwan gradually softened its interpretation of the ‘three noes policy’ to cope with the reality of increasing contacts and thriving indirect trade. In July 1985, Taiwan indicated that it would not interfere in indirect exports, as it could not control it. Indirect imports, however, would still be subject to control. Import controls on Mainland products were gradually liberalized from 1987 onwards. Items allowed to be indirectly imported increased from 29 (July 1987) to 90 (January 1989) to 155 (early 1990) and then to 1654 items by the end of 1993 (Yeh 1995:62). In July 1996, Taiwan liberalized by changing from positive licensing to negative licensing, whereby imports would be freely allowed unless they fell within the controlled list, though positive licensing was retained for agricultural products. Taiwan has also liberalized the interpretation of indirect investment. Small investors do not have to form subsidiaries overseas. Since 1992, for any investment under US$1 m., the investor has been able to remit the funds to China as long as it is done through a third place. However, investment in high-tech and defence projects are prohibited. With the opening of the Macau international airport in 1996, Taiwanese have been able to fly to the Mainland without changing planes, though the plane has to touch down in Macau and also to change its flight number for the second leg of the journey. On 22 January 1997, Taiwan and China concluded an agreement in Hong Kong agreeing to allow ships owned by Taiwanese or Mainlanders that carry flags of convenience to sail direct between Kaohsiung and two Mainland ports in Fujian, namely Xiamen and Fuzhou. This is a far cry from full-scale direct shipping, as Taiwan only allows the ships to carry cargo between the Mainland and third countries via a transhipment zone in the Taiwanese seaport of Kaohsiung. Direct shipping of Taiwanese cargo to the Mainland or vice versa is not allowed. As the transhipment zone is outside Taiwanese customs, it is not considered to be a violation of Taiwan’s prohibition on direct shipping. The impact on Hong Kong is estimated to be less than 1 per cent of Hong Kong’s shipping. However, the impact on Hong Kong of a full-scale

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development of direct shipping could be more serious, as is detailed in Chapter 8.

Tensions and rapprochement across the Taiwan Strait Since 1994, cross-Strait relations have progressively deteriorated. At the end of March 1994, 24 Taiwanese tourists died in a fire on a pleasure boat on Lake Qiandao in Zhejiang. Robbery with the connivance of local officials was suspected. The Mainland’s inept handling and cover-up raised indignation and anti-Mainland sentiments in Taiwan. Despite the outrage of public sentiment in Taiwan, economic interests would have led to continuing rapprochement. Political developments, however, drifted in the opposite direction. Taiwan’s continuing attempt to break out of diplomatic isolation led to the ‘unofficial’ visit of Lee Teng-hui to Cornell University, his alma mater, to receive an honorary doctorate in June 1995. This was followed by Taiwan’s first direct presidential election in March 1996. This historical election was viewed as a crucial step in Taiwan’s drive towards an independent political entity. China’s reaction was to stage three waves of military exercises and missile tests near Taiwan, in mid-July and mid-August 1995, and in March 1996. The last exercise was clearly staged to influence Taiwan’s election. The USA reacted by sending a naval task force with two aircraft carriers to the region. China’s militancy was counterproductive. Lee won the contest with a 54 per cent majority. China’s military exercises in the Taiwan Strait and the confrontation with the USA reminded the world that the continuous economic integration of the China Circle is not a forgone conclusion. Taiwan’s plan to develop Taipei as a regional operations centre suffered a serious setback, as investors were nervous about the possible outbreak of hostilities in the future. After the election, Lee Teng-hui toughened his Mainland policy. On 15 August 1996, he announced a policy of jieji yongren (‘no haste, be patient’) to restrict investments in the Mainland. Large investments in sensitive sectors such as high-tech manufacturing, and investment ventures exceeding US$50 m., were discouraged. Large Taiwanese businesses had to slow down their plans to invest in the Mainland. The second ‘Wang–Koo’ talks in October 1998 did not achieve much progress. Lee Teng-hui’s ‘two states theory’ (that relations between Taiwan and the Mainland should be relations between two states) proposed in 1999 heightened tensions. In the 2000 presidential election,


the KMT (Kuomintang, or Nationalist Party), the ruling party in Taiwan since the end of World War II, was ousted, and Chen Shui-bian, candidate of the pro-independence DPP, was elected. The Mainland stresses that the principle of ‘one China’, which is not accepted by Chen Shui-bian, is a precondition for talks. Mainland–Taiwan relations are at a stalemate. Economic ties, however, have continued to develop. In 2001, as a result of the world economic slowdown and the political uncertainties after Chen Shui-bian’s election, Taiwan’s economy contracted by 1.9 per cent, the first record of negative annual growth since data become available in 1951. Public pressure to liberalize on trade and investment with the Mainland rose and Taiwan agreed to change its ‘no haste, be patient’ policy to one of ‘active liberalization with effective management’ in August 2001. The details of the new policy were implemented in 2002 after the entry of the Mainland and Taiwan into the WTO. First, restrictions on investment in agricultural and industrial products were relaxed, allowing for investment in 8163 items, or close to 94 per cent of the total. Second, restrictions in services and basic infrastructure were also relaxed, allowing for investment in 68 items in services. Third, the ceiling of US$50 m. on large-scale investment was abolished. A new special case screening mechanism is used for investments over US$20 m. Any investment of less than US$20 m. is deemed to be approved if it is not rejected one month after application. After WTO entry in 1 January 2002, Taiwan liberalized its import prohibitions and its restrictions on inward FDI from the Mainland, as such restrictions are contrary to WTO rules. In February 2002, Taiwan allowed direct trading, investment and remittances with the Mainland, though direct shipping was still not allowed. The number of Mainland goods allowed for import rose to 7700 items, or close to 73 per cent of the total of product items, up from 56 per cent previously. From August 2002, Mainland investment in Taiwanese real estate was allowed. Of the 108 items in the services sector open to other countries, 58 items would be open to Mainland capital. Despite Taiwan’s liberalizations, Taiwan’s rules on imports and inward FDI still discriminate against the Mainland. However, the Mainland does not want to raise the issue in the WTO as the Mainland regards cross-strait issues as China’s internal affairs that should not be discussed in international forums. Internationalization of cross-strait issues is regarded as being in Taiwan’s interests. As a result, Taiwan is going slow in the liberalization of its bans against the Mainland that are contrary to WTO rules.

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It should be stressed that, even according to WTO rules, entry into the WTO does not imply automatic establishment of ‘three links’, as WTO rules on air and shipping links are vague. Air and shipping links are subject to bilateral negotiation, which can get stuck for all kinds of reasons. Direct air and shipping links have to wait for the resolution of political differences with the Mainland. Mini three links for offshore islands Taiwan controls Quemoy, Matsu and some other small islands off the shore of Fujian province. Smuggling through fishing vessels had existed since the early 1980s. Fujian regulated such ‘minor trade’ in 1986, limiting it to vessels under 100 dead-weight tonnage (d.w.t.). In 1993, China’s State Council announced national regulations for ‘minor trade’, limiting transactions to US$100 000 each. Some fees and taxes have to be paid. Minor trade is very small, usually less than 1 per cent of Mainland–Taiwan trade. It declined in the 1990s owing to the progressive liberalization in Taiwanese regulations, and was only US$100 m. in 2000, or 0.3 per cent of regular trade. While ‘minor trade’ was legal for the Mainland, it was smuggling for Taiwan. After the election of Chen Shui-bian in 2000, Taiwan exempted the offshore islands and the Penghu islands from the ‘three noes’ policy. The first passenger ships sailed from Matsu and Quemoy to Fujian on 2 January 2001. The impact of ‘mini three links’ is limited, as ‘minor trade’ is small and had long been legal for the Mainland. Though there is potential for developing passenger traffic between the offshore islands and Fujian, development is slow because only Taiwanese businessmen in Fujian are allowed to fly to Taiwan via Quemoy. The Mainland is unlikely to cooperate and allow Chen Shui-bian to reap political capital from ‘mini three links’ to divert pressure to establish full-scale direct links. Despite the clamour from Taiwan’s business community to allow direct links with the Mainland, the Taiwanese government is moving very slowly because of political and security concerns.

Hong Kong–Taiwan relations During the era of the cold war, Hong Kong had no official ties with Taiwan, as Britain recognized Beijing in 1949 and broke off its diplomatic ties with Taiwan. Under Britain’s instructions, Hong Kong banned Taiwan officials from entering Hong Kong on official business in 1955 after Taiwan agents sabotaged an aeroplane carrying


Mainland diplomats from Hong Kong to Jakarta for the Bandung Conference. Despite the Hong Kong ban on Taiwan officials, trade between Hong Kong and Taiwan grew rapidly because both economies achieved very high rates of growth. Before 1987, the economic ties between Hong Kong and Taiwan were one-sided, owing to Taiwan’s trade protectionism and foreign exchange controls. However, economic ties between Hong Kong and Taiwan developed extremely rapidly in the late 1980s with the liberalization of Taiwan’s imports and foreign exchange controls, the sharp appreciation of the Taiwanese currency and Taiwan’s use of Hong Kong as an intermediary in its interactions with the Mainland. In April 1991, Taiwan established the Taipei Centre in Hong Kong to help Taiwanese investors establish paper companies in Hong Kong for investment in the Mainland. Hua Nan Commercial Bank, one of the three largest commercial banks in Taiwan, was the first Taiwanese bank to be given permission to have a branch in Hong Kong in July 1993 (South China Morning Post, Hong Kong, 19 July 1993:A1). With the rapid growth in economic links and the lessening of tension across the Taiwan Strait, official or semi-official relations between Hong Kong and Taiwan have improved despite the absence of diplomatic ties. The Hong Kong Trade Development Council opened an office in Taipei in 1988 to promote Hong Kong exports. In 1991, the Hong Kong government allowed a Taiwan official, John Ni, to come to Hong Kong to head the Zhonghua Travel Service, which was the covert Taiwan representation in Hong Kong. The action broke the 1955 ban on Taiwan officials entering Hong Kong on official business. Hong Kong–Taiwan links after 1997 After the reversion of Hong Kong to China, China’s strategy is to use the HKSAR as an example to woo Taiwan back into the fold. Taiwan has fears that its links with Hong Kong will be used by the Mainland against Taiwan’s interest. Since 1 July 1997, for the purpose of visiting, residing and investing in Taiwan, Hong Kong residents have had fewer rights than before because they are regarded as foreigners rather than overseas Chinese. The political tension in Mainland–Taiwan relations also spilled over into Hong Kong–Taiwan relations. In 1999, Cheng An Kuo, head of the Zhonghua Travel Service, had to leave Hong Kong because of his public statements supporting Lee Teng-hui’s ‘two states theory’ in a Hong Kong radio programme. His successor, Chang Leung-jen, arrived in Hong Kong in January 2001.

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The Taiwanese connections of the Hong Kong people were mostly with the KMT rather than the DPP. The election of the DPP candidate Chen Shui-bian in 2000 implied that Hong Kong’s personal networks in Taiwan are less useful. This includes the personal Taiwanese connections of Tung Chee-hwa, chief executive of the HKSAR, whose sister is married to a former high-ranking official in Taiwan. Despite political problems, economic interests dictate closer ties. Taiwan has continued to rely on Hong Kong as its middleman after 1997 because rerouting Taiwan’s trade and investment with the Mainland through other places could be much more costly. Taiwan distinguishes Hong Kong as a special region different from the Mainland as long as Hong Kong remains a ‘free and democratic economic entity’ (United Daily News, 8 May 1993), and Taiwan’s air and shipping links with Hong Kong will be treated as special links that are neither domestic nor international. According to the Sino–British Declaration on Hong Kong, Hong Kong’s air and shipping links with Taiwan have to be approved by Beijing. In late May 1997, Hong Kong and Taiwan reached an agreement on shipping. Taiwanese vessels are allowed to enter Hong Kong without hoisting a flag. Beijing, partly out of concern for Hong Kong’s economic interests, has allowed Taiwan to use Hong Kong as the middleman since 1997. Visa applications between Hong Kong and Taiwan had been very cumbersome on both sides, owing to fear of espionage and political problems. In 1998, the tourist industries in both Taiwan and Hong Kong were suffering from the Asian financial crisis, and each government moved to ease visa applications. In April 1998, Taiwan speeded up the processing of visas for Hong Kong residents from two weeks to one, and multiple-entry visas valid for three years were granted for frequent travellers. In June 1998, Hong Kong also liberalized visa controls for Taiwanese. The processing of multiple-entry visas valid for three years was speeded up from five days to two. Taiwanese who have already obtained Mainland visas are allowed to stay in Hong Kong for seven days without a Hong Kong visa before or after their Mainland trip. In July 2001, visa formalities were further simplified. Taiwan allowed Hong Kong residents who have travelled to Taiwan before to apply for visa upon entry. In March 2002, Hong Kong allowed Taiwanese visitors to apply for visas online, cutting the processing time from a week to several minutes. In mid-2002, Taiwan and Hong Kong reached a five-year air agreement that allowed for more flights and the participation of six airlines


to accommodate the rapid increase in traffic between Taiwan and Hong Kong. The impact on Hong Kong of direct Taiwan–Mainland air and shipping links will be examined in Chapter 8.

A new brand of ‘new-style’ integration Economic literature distinguishes between the ‘old-style’ integration, based on multilateral negotiation and discriminative tariff preferences as exemplified by the European Union, and the ‘new-style’ integration, centred on policy coordination as exemplified by the APEC (Asian Pacific Economic Community). Old-style integration has to be under the WTO framework because it involves discriminatory tariff preferences, while new-style integration is more flexible because discriminatory tariffs are not involved. New-style integration is increasingly popular, partly because of its flexibility and also partly because services trade, which is of increasing importance, cannot be handled under the framework of discriminatory tariff preferences. Promotion of services trade requires policy coordination. Of course, old- and new-style integration are not exclusive. For example, both the EU and the NAFTA involve discriminatory tariff preferences and also policy coordination. The integration of Greater China is unique in many ways. Old-style integration was quite irrelevant as Taiwan has always refused to deal directly with the Mainland. While the Mainland–Hong Kong CEPA took effect in early 2004, the intense trade and investment flows in the CEA have developed without the benefit of a RTA. While Greater China can be taken as a successful example of newstyle integration, it has two peculiar twists. First, Hong Kong and the Mainland have been one country since 1997, and the policy coordination between Hong Kong and the Mainland involves coordination of a central government and a local government under the framework of ‘one country, two systems’. Indeed, the Mainland–Hong Kong CEPA is the first FTA formed between two custom territories of the same nation. Second, the policy coordination between the Mainland and Taiwan is quite informal because of political animosity. Most of the policy interactions between Taiwan and the Mainland were not the outcome of governmental negotiations. Instead, they were a series of unilateral moves undertaken in the anticipation of reciprocal moves by the other party. While the process is cumbersome, it has achieved remarkable results in terms of trade and investment flows, and has also led to very close economic ties across the Taiwan Strait.

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The new brand of new-style integration exemplified by the CEA is indeed very flexible. It shows what can be achieved through pragmatic policies, as long as governments allow market forces to work, even if the market forces are working on two political entities that refuse to recognize each other. The integration of Greater China is an amazing example of Chinese pragmatism. It is an illustration of the famous dictum of Deng Xiaoping, the architect of China’s opening, that ‘I don’t care whether the cat is white or black as long as it catches mice.’

4 Trade Between Hong Kong and the Mainland

The wealth of data on Hong Kong–Mainland trade enables us to analyse in detail the many economic interactions between Hong Kong and the Mainland. Hong Kong’s role as the Mainland’s foremost entrepot is important not only for Hong Kong and the Mainland, but also for the trading partners of China, as substantial portions of their trade with the Mainland are channelled through Hong Kong. Hong Kong and the Mainland are often considered each other’s foremost trading partners, which is misleading because such trade includes Mainland’s trade with third countries via Hong Kong (Hong Kong’s entrepot trade). As the Mainland’s trade with third countries via Hong Kong is very large, the Mainland’s trade with its trading partners is highly distorted because both the Mainland and its partners often regard their exports to their final destinations via Hong Kong as exports to Hong Kong. Fortunately, Hong Kong trade statistics distinguish entrepot trade from trade with Hong Kong itself. This book relies on Hong Kong’s re-export statistics to estimate the Mainland’s trade with Hong Kong and Taiwan. This chapter will analyse in detail the determinants of Hong Kong’s entrepot trade, as such trade constitutes close to 90 per cent of Hong Kong–Mainland trade. The prospect of Hong Kong as the Mainland’s entrepot will be examined, because there has been diversion of the Mainland’s trade from Hong Kong to other ports in Guangdong in recent years. Services trade between the Mainland and Hong Kong will also be analysed, as it is large and growing rapidly. The Mainland’s WTO entry in late 2002 and the implementation of the Mainland–Hong Kong CEPA in early 2004 have had significant impacts on commodity and services trade between the Mainland and Hong Kong, as will be explained below. 73

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Complications of the Mainland’s trade statistics Up to 1992, the Mainland included in its imports from Hong Kong a substantial amount of third-country goods re-exported via Hong Kong to the Mainland because the Mainland was unable to ascertain the true origin of the vast amount of third-country products imported through Hong Kong. The Mainland thus exaggerated imports from Hong Kong and regarded Hong Kong as its top supplier (and also its foremost market) in 1992. Since 1993, the Mainland had been able to improve on its classification of imports by origin, and its imports from Hong Kong have no longer included Hong Kong’s re-exports of third economies to the Mainland. As a result, in 1993, Hong Kong dropped from the first to the fourth supplier of imports to the Mainland (after Japan, Taiwan and the USA). However, as mentioned in Chapter 1, the Mainland’s trade via Hong Kong with third countries continues to distort the statistics of the Mainland’s bilateral trade. In trade statistics, exports are usually classified by region of consignment, while imports are classified by region of origin, as tariffs and quota often depend on the region of origin. The Mainland thus overstates its exports to Hong Kong and understates its exports to other countries. Other countries similarly overstate their exports to Hong Kong but understate their exports to the Mainland. Imports are not understated, as they are traced to the country of origin. Statistics on bilateral trade deficits or surpluses are thus seriously distorted. The case of USA–Mainland trade has received great attention due to the sheer size of the trade imbalance. Both China and the USA overstate their bilateral trade deficits or understate their bilateral surpluses. For example, in 1992, US statistics claimed a deficit of US$18 bn in US trade with China, whereas China claimed a trade deficit of US$306 m. with the USA! However, American statistics are less misleading than those of China, because in the early 1990s, around two-thirds of China’s exports to the USA were re-exported through Hong Kong, whereas the corresponding percentage of the USA was only around 20 per cent. Because of pressure from the USA, the Mainland tried to trace the final destination of its exports via Hong Kong, and a substantial portion of its exports to Hong Kong were reclassified as exports to final destinations in 1993. As a result of the reclassification, the Mainland’s exports to Hong Kong dropped by 41 per cent, and the Mainland’s exports to the USA, Japan and Germany grew by 97, 35 and 62 per cent respectively in 1993. Despite the reclassification, a substantial portion of the

Trade Between Hong Kong and the Mainland 75

Mainland’s exports via Hong Kong to third countries are still classified as exports to Hong Kong because the Mainland is unable to trace the final destination of all of its exports via Hong Kong. Hong Kong remained the foremost market for Chinese exports in Chinese statistics till 1998. Even in 2002, Hong Kong was still the second largest market in Chinese statistics, taking 1 per cent of the Mainland’s exports. In reality, Hong Kong consumed less than 1 per cent of the Mainland’s exports in 2003 (see below).

Hong Kong’s re-export statistics and the re-export margin Owing to the vast amount of the Mainland’s goods re-exported elsewhere via Hong Kong, it would be more meaningful for the Mainland to classify its exports by region of final destination (or region of consumption). However, the Mainland may not be aware of the final destination after the goods are sold to Hong Kong traders. The data can be obtained only from Hong Kong’s data on re-exports of Mainland origin. While Hong Kong has data on re-exports of Mainland origin, the value of re-exports exceeds that of imports for re-exports by the reexport margin, or value added in Hong Kong, which must be deducted to estimate the value of the Mainland’s exports that are re-exported via Hong Kong. The re-export margin includes costs of storage, transportation within Hong Kong, and maybe costs of packaging and minor processing that are not substantial enough to change the form and nature of the product (otherwise, the product will be regarded as Hong Kong’s domestic exports; that is, exports made in Hong Kong, and not re-exports). Though the Hong Kong government has detailed statistics on imports, domestic exports and re-exports, there are no statistics on imports for re-export because the importer may not be able to ascertain whether the imported good will be re-exported. A good imported into Hong Kong may change hands many times before eventual re-exportation. The reexport margin can thus be obtained only through survey data. Given the re-export margin, imports for re-exports can be obtained from the value of re-exports. Then the value of retained imports (that is, imports retained in Hong Kong for internal use) is obtained as the difference between total imports and imports for re-export. The Census and Statistics Department of the Hong Kong government has conducted surveys on Hong Kong’s re-export margin and the results were first released in February 1996 (Census and Statistics Department, Hong Kong, 1996). The rate of re-export margin for Mainland goods rose from 13 per cent in 1989 to a peak of 39.9 per cent in 2000 (Table

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The Emergence of Greater China Table 4.1 Hong Kong’s re-exports margin by origin (percentages) Year

Mainland

Others

Overall

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

13.0 21.1 25.8 29.7 35.3 33.2 32.8 34.4 34.6 35.1 38.3 39.9 37.0 34.2 31.4

11.5 12.7 10.3 10.3 8.5 6.0 5.9 6.6 7.4 8.6 9.6 10.5 10.6 11.9 9.9

12.2 17.4 18.9 20.8 22.4 20.0 19.8 21.4 21.7 23.0 25.5 26.7 25.3 23.6 21.8

Source: Census and Statistics Department, Hong Kong.

4.1).1 The increase of the rate is due largely to the rise in the share of products from outward-processing operations in Hong Kong’s re-exports of Mainland origin, as Hong Kong firms are likely to provide more valueadding services for the goods they produce in the Mainland. However, the rate of re-export margin declined from 2000 to 31.4 per cent in 2003. This probably indicates that the Mainland was able to provide more of the supporting services locally instead of sourcing them from Hong Kong. In particular, the rapid development of ports in Shenzhen has put a lot of pressure on the ports in Hong Kong. The Mainland’s exports to Hong Kong should be Hong Kong’s imports from the Mainland less the costs of insurance and freight, which create a differential between the value of exports (in f.o.b. or ‘free on board’ prices) and the value of imports (in c.i.f. or ‘cost, insurance and freight’ prices). The differential is obtained from survey data. The differential is only one per cent for Hong Kong–Mainland trade, but 4.3 per cent for Hong Kong–USA trade as the distance involved is much greater.2 For Mainland goods re-exported via Hong Kong to the USA, the American c.i.f. price is much higher than Mainland’s f.o.b. price. In 2000, the differential was 47 per cent, part of which was the 39.9 per cent re-export margin (1.01 ¥ 1.399 ¥ 1.043 = 1.47). For Mainland goods


re-exported via Hong Kong, the c.i.f.–f.o.b. differential is huge. Ignoring this differential will give bad estimates.

Hong Kong as the middleman in the Mainland’s trade Given the re-export margins and c.i.f.–f.o.b. differentials, we can make the estimates presented in Table 4.2, which gives the Mainland’s trade with third countries via Hong Kong, and also the Mainland’s trade with Hong Kong. The latter includes the trade with third countries via Hong Kong and also the trade with Hong Kong itself (that is, exports retained for internal use in Hong Kong and imports of Hong Kong goods). In this chapter, the Mainland’s exports to Hong Kong and imports from Hong Kong are respectively taken to be Hong Kong imports from the Mainland and Hong Kong exports to the Mainland, as the c.i.f.–f.o.b. differential is just 1 per cent. To highlight Hong Kong’s important role as a middleman in the Mainland’s trade, the Mainland’s trade through Shanghai customs (including Shanghainese and nonShanghainese products) is included for comparison. With China’s opening, Hong Kong regained its historic role as the Mainland’s entrepot, surpassing Shanghai as China’s foremost international port. The share of the Mainland’s trade with third countries via Hong Kong rose from 4.3 per cent in 1979 to around 40 per cent in the mid-1990s, while Shanghai’s share of the Mainland’s trade declined from over 20 per cent in 1985 to 15 per cent in 1994. It should be noted that the Mainland’s trade via Hong Kong has grown much faster than the trade with Hong Kong itself. From 1979 to 1997, the former grew a hundredfold, rising from 4.3 per cent to 39 per cent of the Mainland’s trade, while the latter rose only 6.3 times, falling from 7.4 per cent to 4.3 per cent of the Mainland’s trade. The Asian financial crisis led to a fall in Mainland–Hong Kong trade in 1998 and 1999. There was a sharp rebound in 2000, but the slowdown of the world economy in 2001 and the terrorist attack of 11 September led to another downturn. Recovery was again rapid in 2002 and 2003. Hong Kong as middleman: entrepot trade and offshore trade Cyclical factors aside, there has evidently been a structural decline in the importance of Hong Kong as the Mainland’s trading partner since the late 1990s as competition from Mainland ports has led to a dramatic slowdown in the growth of the Mainland’s trade via Hong Kong. The average annual rate of growth of the Mainland’s trade via Hong Kong

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Table 4.2 Mainland’s trade via Shanghai and Hong Kong (US$ m.) Figures in brackets represent percentage share of China’s total. China’s trade via Hong Kong with third countries†

China’s trade with Hong Kong‡

Imports

Total trade

Exports

Imports

Total trade

Exports

Imports

– – 9 965 (23.6) 11 726 (19.8) 10 258 (16.1) 13 181 (16.4) 16 954 (16.3) 17 308 (15.0) 22 530 (17.1) 25 656 (18.5)

1 265 (4.4) 9 840 (14.1) 34 630 (31.0) 51 952 (38.3) 61 263 (37.0) 80 772 (41.3) 94 819 (40.1) 111 636 (39.7) 119 771 (41.3)

1 002 (7.3) 3 933 (14.4) 21 362 (40.7) 32 296 (44.9) 34 070 (40.1) 45 281 (49.4) 53 043 (43.8) 61 954 (41.6) 65 756 (43.5)

263 (1.7) 5 907 (14.0) 13 268 (22.4) 19 656 (30.8) 27 193 (34.9) 35 491 (34.1) 41 776 (36.1) 49 682 (37.6) 54 015 (38.9)

3 428 (11.7) 15 306 (22.0) 43 247 (38.7) 63 342 (46.7) 79 323 (47.9) 93 848 (47.9) 108 372 (45.8) 122 158 (43.5) 133 130 (45.9)

3 045 (22.3) 7 449 (27.3) 24 431 (46.5) 36 711 (51.1) 44 187 (52.0) 50 165 (54.7) 58 702 (48.6) 64 254 (43.2) 71 148 (47.1)

383 (2.5) 7 857 (18.6) 18 816 (31.8) 26 631 (41.7) 35 136 (45.1) 43 683 (42.0) 49 670 (42.9) 57 904 (43.8) 6 1982 (44.6)

Via Shanghai* Total trade 1979 1985 1989 1991 1992 1993 1994 1995 1996

– – 14 873 (21.4) 19 437 (17.4) 20 409 (15.1) 25 145 (15.2) 30 931 (15.8) 36 246 (15.3) 48 138 (17.1) 52 869 (18.2)

Exports 3 675 (26.9) 4 908 (18.0) 7 711 (14.7) 10 151 (14.1) 11 964 (14.1) 13 977 (15.2) 18 938 (15.7) 25 608 (17.2) 27 213 (18.0)

1997 1998 1999 2000 2001 2002 2003

58 682 (18.1) 63 637 (19.6) 76 144 (21.1) 109 311 (23.0) 120 483 (23.6) 142 459 (22.9) 201 125 (23.6)

33 450 (18.3) 37 453 (20.4) 44 281 (22.7) 61 572 (24.7) 68 002 (25.5) 81 778 (25.1) 112 243 (25.6)

25 232 (17.7) 26 184 (18.7) 31 863 (19.2) 47 739 (21.2) 52 481 (21.5) 60 682 (20.6) 88 882 (21.5)

126 758 (39.0) 118 642 (36.6) 118 567 (32.9) 140 632 (29.7) 139 318 (27.3) 155 837 (25.1) 185 149 (21.8)

69 424 (38.0) 66 045 (36.0) 67 112 (34.4) 77 962 (31.3) 75 655 (28.4) 82 520 (25.3) 94 512 (21.6)

57 334 (40.3) 52 597 (37.5) 51 455 (31.0) 62 670 (27.8) 63 663 (26.1) 73 317 (24.8) 90 637 (22.0)

140 936 (43.3) 131 343 (40.5) 132 604 (36.8) 157 353 (33.2) 153 632 (30.1) 166 872 (26.9) 192 472 (22.6)

75 353 (41.2) 71 507 (38.9) 74 651 (38.3) 87 740 (35.2) 83 616 (31.4) 88 251 (27.1) 97 115 (22.2)

65 583 (46.1) 59 836 (42.7) 57 953 (35.0) 69 613 (30.9) 70 016 (28.7) 78 621 (26.6) 95 357 (23.1)

* Includes products imported/exported by other provinces via Shanghai’s customs. † Includes only China’s trade with third countries in the form of Hong Kong re-exports. ‡ Includes also China’s exports retained in Hong Kong and China imports of Hong Kong goods in addition to China’s trade via Hong Kong. Sources: Trade via Shanghai: data since 1993 were obtained from China Customs Statistics, Economic Information and Agency, Hong Kong; data before 1993 were obtained from The Foreign Economic Statistical Yearbook of Shanghai, Shanghai Statistical Bureau (internal document). Mainland’s trade via Hong Kong and with Hong Kong: Hong Kong External Trade, Census and Statistics Department, Hong Kong, various issues. Mainland’s exports to (imports from) Hong Kong are taken to be Hong Kong’s imports from (exports to) the Mainland.

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dropped from 31 per cent in the period 1979–96 to only 6 per cent in the 1996–2003 period. The share of the Mainland’s trade via Hong Kong with third countries peaked at 41.5 per cent in 1996, and declined to 21.5 per cent in 2003. In contrast, Shanghai’s share of the Mainland’s trade rose from 15 per cent in the early 1990s to 23.6 per cent in 2003. However, slightly over half of China’s trade via Shanghai’s customs represents exports of Shanghainese products or imports used in Shanghai. For the case of the Mainland’s trade via Hong Kong, exports of Hong Kong goods and imports used in Hong Kong are not included. If we just look at the Mainland’s non-Shanghai trade via Shanghai, Shanghai’s 2003 share would drop to 10.6 per cent, which is still considerably less than the 21.5 per cent share of Hong Kong. However, given the rapid narrowing of the gap, it is likely that Shanghai will surpass Hong Kong as the Mainland’s foremost international port in the not too distant future. It is important to examine in detail the role of Hong Kong as a middleman because of its significance for both Hong Kong and the Mainland. Besides the Mainland’s trade with third countries via Hong Kong in the form of entrepot trade, Hong Kong firms also play an important role in the Mainland’s trade not going through Hong Kong’s customs. From Hong Kong’s point of view, this is regarded as Hong Kong’s offshore trade. There are two main ways of shipping offshore trade, direct shipment and transhipment via Hong Kong. In direct shipment, the goods are shipped from the source to the destination without touching Hong Kong. In transhipment, the goods are consigned from the source direct to the destination, though the goods are transported via Hong Kong and usually change vessels in Hong Kong. Mainland goods, for example, are carried by coastal vessels to Hong Kong, where they are consolidated into containers for ocean shipping. Unlike re-exports, transhipment is not part of Hong Kong’s trade, as there is no Hong Kong buyer. As the goods do not go through Hong Kong customs, their value is not known, though their weight and volume are known from cargo statistics. Hong Kong’s role as a middleman in the Mainland’s trade takes the following forms: 1. Re-exports (entrepot trade) – Hong Kong companies buy goods outside Hong Kong for resale elsewhere, and the goods are imported into Hong Kong for re-exporting. The goods clear customs twice, the first time during importation and the second time during exportation.


2. Middleman in offshore trade – The goods do not go through Hong Kong customs. Hong Kong firms play a role in merchanting or merchandising. a. Merchanting – Hong Kong traders buy goods outside Hong Kong for export elsewhere, and such goods do not go through Hong Kong customs. b. Merchandising – Hong Kong traders arrange on behalf of buyers/sellers outside Hong Kong the purchases/sales of goods without taking ownership of the goods involved, and such goods do not go through Hong Kong customs. Reasons for transhipment and re-exports Transhipment is used when direct shipment is not possible or not economical. Due to the hub-and-spoke pattern in transportation, transhipment through a major hub that has frequent schedules is often faster than direct shipment. Given Hong Kong’s position as the shipping hub of South China, it is not surprising that a substantial amount of the Mainland’s trade is transhipped through Hong Kong. Compared with transhipment, re-exports are usually more expensive as they have to clear Hong Kong customs twice. A fee of 0.05 per cent is levied on Hong Kong’s trade to finance the Hong Kong Trade Development Council. Re-exports have to pay the fee twice. Re-exports thus involve other factors in addition to transportation. These factors include the following: 1. The possible need for the goods to be processed, packaged or inspected (for quality control) in Hong Kong. In such cases, the goods must be imported into Hong Kong, and the one who is responsible for processing or inspection must own the goods in question. 2. The fact that, before 1992, China restricted foreign investment in shipping and cargo forwarding in China. It was difficult to arrange transhipment or direct shipment in China. 3. The possibly considerable expense of paying shipping companies to handle transhipment of small lots of cargo; it may be preferable for the Hong Kong headquarters to import and consolidate small lots from different subsidiaries in the Mainland for export in Hong Kong. Change in Hong Kong’s middleman role in the Mainland’s trade From China’s opening to the mid-1990s, Hong Kong’s middleman role in the Mainland’s trade was carried out mainly in the form of re-exports through Hong Kong. As mentioned before, the share of the Mainland’s trade taking the form of Hong Kong re-exports rose from 4 per cent in

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1979 to 40 per cent in the mid-1990s. Since the mid-1990s, there has been a rapid shift in Hong Kong’s middleman role from re-exports to offshore trade, in which goods are sometimes transhipped via Hong Kong but are more often directly shipped without touching Hong Kong. Hong Kong’s offshore trade has grown very rapidly, while the rate of growth of the Mainland’s trade taking the form of Hong Kong re-exports fell markedly, from an average of 31 per cent per year during the period 1979–96 to 6 per cent per year from 1996 to 2003. On the other hand, Hong Kong’s offshore trade grew at the rapid rate of 14 per cent per year from 1994 to 2000 (Hong Kong Trade Development Council, 2001). The shift from re-exporting to transhipment and direct shipment is easily explained. With the increasing sophistication of manufacturing in Guangdong, there has been virtually no need to bring the goods into Hong Kong for quality control or packaging since the mid-1990s. Moreover, China relaxed the restrictions against foreign investment in container terminals, shipping and cargo forwarding after Deng Xiaoping’s 1992 tour in support of economic reforms. Hong Kong’s main container handler, Hutchison Whampoa, invested in many ports in Guangdong and rapidly built up its cargo handling capacity. It has been much easier to arrange direct shipment or transhipment in the Mainland since the mid-1990s. The rise of direct shipment has been especially rapid, as the costs of Mainland ports are much lower than those of Hong Kong. In view of the rising importance of offshore trade, detailed statistics on Hong Kong’s Mainland-related offshore trade since 2000 were released in 2002 by the Hong Kong government. Table 4.3 shows Hong Kong’s re-exports and offshore merchanting of goods related to the Mainland. For goods exported from the Mainland, merchanting of goods has grown very rapidly, and was 86 per cent of Hong Kong’s imports from the Mainland for re-export in 2002. Merchandising is not included because breakdown by source is not available. In any case, merchandising is quite small in comparison with merchanting. While there are the usual year-to-year fluctuations, the average annual growth rate of Hong Kong’s Mainland-related re-exports from 1996 to 2002 was only 4.4 per cent. The double-digit growth of Hong Kong’s Mainland-related re-exports in 2000 only represented a recovery from Hong Kong’s deep recession of 1998–9 triggered by the AFC (Asian financial crisis). In 2001, the growth of Hong Kong’s Mainland-related reexports was a negative 0.9 per cent, while Hong Kong’s Mainland-related offshore trade still grew by close to 19 per cent. Given such trends, Hong Kong’s Mainland-related offshore trade will soon surpass its Mainlandrelated re-exports.

Table 4.3 Hong Kong’s re-exports and offshore merchanting of goods related to the Mainland (i) Percentage share of the Mainland’s exports/imports/trade. (ii) Growth rate in per cent. Goods to Mainland

Goods from Mainland

2000 (i) (ii) 2001 (i) (ii) 2002 (i) (ii)

Goods to and from Mainland

Imports for Re-exports

Merchanting

Total

Re-exports

Merchanting

Total

Re-exports

Merchanting

Total

77 962 (31.3) (16.2) 75 655 (28.4) (-3.0) 82 520 (25.3) (9.1)

43 950 (17.6) – 58 810 (22.1) (33.8) 71 005 (21.8) (20.7)

121 912 (48.9) – 134 465 (50.5) (10.3) 153 525 (47.2) (14.2)

62 670 (27.8) (21.8) 63 663 (26.1) (1.6) 73 317 (24.8) (15.2)

44 029 (19.6) – 45 761 (18.8) (3.9) 49 230 (16.7) (7.6)

106 699 (47.4) – 109 424 (44.9) (2.8) 122 547 (41.5) (12.0)

140 632 (29.7) (18.5) 139 318 (27.3) (-0.9) 155 837 (25.1) (11.9)

87 979 (18.5) – 104 571 (20.5) (18.9) 120 235 (19.4) (15.0)

228 611 (48.2) – 243 889 (47.9) (7.3) 276 072 (44.5) (13.2)

Sources: Commodity trade taken from Table 4.2. Merchanting data taken from Report on Hong Kong Trade in Services Statistics for 2002, Census and Statistics Department, Hong Kong.

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84


Combing re-exports and merchanting, the role of Hong Kong in the Mainland’s trade is still very substantial: in 2002, Hong Kong handled 47 per cent of the Mainland’s exports, 42 per cent of its imports and 45 per cent of its trade. Despite the relative decline of the Mainland’s trade re-exported via Hong Kong, Hong Kong still handled close to half of the Mainland’s trade if Hong Kong’s role in merchanting offshore trade is included. However, the value added in merchanting is substantially less than that of re-exports. In 2002, the overall re-export margin was 23.6 per cent while the gross margin of merchanting was only 10.5 per cent. While this is to be expected, as merchanting involves less value-adding activities from Hong Kong, it implies that the growth of earnings of Hong Kong from Mainland-related trade has slowed down since the mid-1990s. This is an important factor in the marked slowdown in the economic growth of Hong Kong since 1997. Table 4.4 shows the gross margin earned by Hong Kong from reexports and merchanting of offshore trade related to the Mainland. In 2002, the gross margin from Mainland-related re-export trade was 22 per cent of Hong Kong’s GDP, and the gross margin from merchanting was another 8 per cent of Hong Kong’s GDP, giving a total of 30 per cent of Hong Kong’s GDP. Hong Kong’s earnings from its middleman role in Mainland-related trade are undoubtedly very important in Hong Kong’s economy. Slow growth of Hong Kong’s earnings from its Mainland-related trade cannot fail to have a drastic impact on the Hong Kong economy.

The Mainland’s trade with Hong Kong While Hong Kong’s Mainland-related offshore trade has grown much faster than Mainland–Hong Kong trade since the mid-1990s, Mainland–Hong Kong trade is still very large. Mainland trade with Hong Kong will be examined in detail below. The Mainland’s commodity trade with Hong Kong has always been substantial, and Mainland services trade with Hong Kong has soared rapidly since 1979. Hong Kong’s re-exports are statistically regarded as commodity trade, but it is services trade in disguise, as the value-adding activities contributed by Hong Kong are almost entirely services. The fact that re-export services are embodied in commodities traded is convenient, as statistics on commodity trade are easier to collect. Commodity trade will be analysed in great detail because of the wealth of

Table 4.4 Gross margin of Hong Kong’s re-exports and offshore merchanting of goods related to the Mainland (i) Percentage share of Hong Kong’s GDP. (ii) Growth rate in per cent. Goods to Mainland

Goods from Mainland

2000 (i) (ii) 2001 (i) (ii) 2002 (i) (ii)

Goods to and from Mainland

Imports for Re-exports

Merchanting

Total

Re-exports

Merchanting

Total

Re-exports

Merchanting

Total

31 076 (18.8) (21.4) 27 982 (17.2) (-10.0) 28 245 (17.5) (0.9)

7184 (4.3) – 7532 (3.6) (4.8) 8544 (5.3) (13.4)

38 260 (23.2) – 35 514 (20.8) (-7.2) 36 789 (22.8) (3.6)

5954 (3.6) (32.9) 6112 (3.7) (2.7) 6818 (4.2) (11.6)

3242 (2.0) – 3850 (2.4) (18.8) 4096 (2.5) (6.4)

9 196 (5.6) – 9 962 (6.1) (8.3) 10 914 (6.8) (9.6)

37 030 (22.4) (23.1) 34 094 (20.9) (-7.9) 35 063 (21.7) (2.8)

10 426 (6.3) – 11 382 (5.9) (9.2) 12 640 (7.8) (11.1)

47 456 (28.7) – 45 476 (26.9) (-4.2) 47 703 (29.5) (4.9)

Sources: Derived from Table 4.3 with data on the re-export margin (Table 4.1) and the gross margin of merchanting.

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data available, while the analysis on services trade is brief owing to the lack of data.

The Mainland’s commodity trade with Hong Kong Table 4.5 shows Hong Kong imports from the Mainland (divided into retained imports and imports re-exported elsewhere) and Hong Kong exports to the Mainland (divided into Hong Kong goods and re-exports of third-country goods). Hong Kong was the largest market for Mainland products in the late 1960s and early 1970s, consuming around 16 per cent of the Mainland’s exports. Another 5 per cent of the Mainland’s exports were re-exported via Hong Kong to third countries. Hong Kong thus accounted for around 20 per cent of the Mainland’s exports in total. Food was the major item of trade, accounting for over half of China’s export consumed in Hong Kong. As the Mainland’s imports from Hong Kong were Table 4.5 Mainland–Hong Kong trade (US$ m.) The figures in brackets represent the percentage share of the Mainland’s total exports (imports). The Mainland’s exports to (imports from) Hong Kong are taken to be Hong Kong’s imports from (exports to) the Mainland.

Hong Kong’s imports from Mainland

Total 1931–8 average 1951 1955 1960 1966 1970 1975 1979

87 (31) 151 (20.0) 157 (11.1) 207 (11.2) 487 (21.8) 467 (20.7) 1 378 (19.0) 3 045 (22.3)

Retained in Hong Kong

Re-exported elsewhere

16 (5.8) –

70 (25.2) –

–

–

–

–

384 (17.2) 366 (16) 1066 (14.6) 2043 (14.9)

103 (4.6) 100 (4.7) 312 (4.4) 1 002 (7.4)

Hong Kong’s exports to Mainland

Total 88 (21.5) 281 (23.5) 32 (1.9) 21 (1.1) 12 (0.5) 11 (0.5) 33 (0.5) 383 (2.5)

Hong Kong goods 9 (2.2) – – 2 (0.1) 3 (0.1) 5 (0.2) 6 (0.1) 121 (0.8)

Hong Kong reexports 79 (19.3) – – 19 (1.0) 9 (0.4) 6 (0.3) 28 (0.4) 263 (1.7)

87 Table 4.5 Continued

Hong Kong’s imports from Mainland

1983 1985 1987 1989 1991 1993 1995 1996 1997 1998 1999 2000 2001 2002 2003

Total

Retained in Hong Kong

Re-exported elsewhere

5 890 (26.5) 7 449 (27.3) 14 776 (37.5) 24 431 (46.6) 36 711 (51.1) 50 165 (54.7) 67 254 (45.2) 71 148 (47.1) 75 353 (41.2) 71 507 (38.9) 74 651 (38.3) 87 741 (35.2) 83 616 (31.4) 88 251 (27.1) 97 115 (22.2)

3495 (15.7) 3516 (12.9) 5212 (13.2) 3069 (5.8) 4415 (6.1) 4884 (5.3) 5300 (3.6) 5392 (3.6) 5929 (3.2) 5462 (3.0) 7539 (3.9) 9779 (3.9) 7961 (3.0) 5731 (1.8) 2603 (0.6)

2 395 (10.8) 3 933 (14.4) 9 563 (24.2) 21 362 (40.7) 32 296 (44.9) 45 281 (49.4) 61 954 (41.6) 65 756 (43.5) 69 420 (38.0) 66 045 (36.0) 67 112 (34.4) 77 962 (31.3) 75 655 (28.4) 82 520 (25.3) 94 512 (21.6)

Hong Kong’s exports to Mainland

Total

Hong Kong goods

Hong Kong reexports

2 531 (11.8) 7 857 (18.6) 11 290 (26.1) 18 816 (31.8) 26 631 (41.7) 43 683 (42.0) 57 904 (43.8) 61 982 (44.6) 65 583 (46.1) 59 836 (42.7) 57 953 (35.0) 69 613 (30.9) 70 016 (28.7) 78 621 (26.6) 95 357 (23.1)

856 (4.0) 1950 (4.6) 3574 (8.3) 5548 (9.4) 6976 (10.9) 8191 (7.9) 8222 (6.2) 7967 (5.7) 8249 (5.8) 7239 (5.2) 6498 (3.9) 6943 (3.1) 6352 (2.6) 5304 (1.8) 4720 (1.1)

1 676 (7.8) 5 907 (14.0) 7 669 (17.8) 13 268 (22.4) 19 656 (30.8) 35 491 (34.1) 49 682 (37.6) 54 015 (38.9) 57 334 (40.3) 52 597 (37.5) 51 455 (31.0) 62 670 (27.8) 63 663 (26.1) 73 317 (24.8) 90 637 (22.0)

Sources: Hong Kong data: 1931–8: C.F. Tom (1957) Entrepot Trade and the Monetary Standards of Hong Kong, University of Chicago Press; 1948 and after: Hong Kong Trade Statistics; 1966 and after: Review of Overseas Trade, Census and Statistics Department, Hong Kong. Chinese data: 1931–48: UN Statistical Office, Yearbook of International Trade Statistics; 1950–79: China Statistical Yearbook, China Statistical Publishing House, Beijing; 1981 and after: China Customs Statistics, Economic Information and Agency, Hong Kong.

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negligible, the Mainland’s trade surplus with Hong Kong was around one-fifth of the Mainland’s total exports, and the Mainland used the hard currency thus earned to finance its imports of grain, industrial raw materials, and capital goods from developed countries. Mainland–Hong Kong trade has been transformed in the post-reform period, however, with the re-exported portion of the Mainland’s exports to Hong Kong growing rapidly, to the point where they exceeded the retained portion by 1985. The Mainland’s imports of Hong Kong goods and also of Hong Kong re-exports grew rapidly. Hong Kong re-emerged as a major entrepot for the Mainland, and the Mainland also became a major market for Hong Kong products.

Outward processing trade One reason for the rapid increase in trade between Hong Kong and the Mainland in the reform era is that Hong Kong’s investments in outward processing in the Mainland have generated huge trade flows. In outward processing, the Mainland partners of Hong Kong firms (which can be processing operations or foreign-invested enterprises) process raw materials and semi-manufactures produced in Hong Kong or purchased by the Hong Kong parent in the world market, and the processed output is sold via the parent to the world market. Outward processing thus increases both the domestic exports of semi-manufactures from Hong Kong to the Mainland and also Hong Kong’s Mainland-related entrepot trade. Table 4.6 shows Hong Kong’s trade involving outward processing in the Mainland. The trade grew rapidly in the early 1990s, but more slowly in the late 1990s, reaching a peak in 2000. The slow growth or decline after 1997 is due partly to the AFC and partly to the diversion of trade to ports in Shenzhen. In 2000, Hong Kong’s imports from the Mainland involving outward processing amounted to US$72.7 bn, or 79 per cent of Hong Kong’s total imports from the Mainland. The bulk of Hong Kong’s imports involving outward processing were re-exported to third countries. These imports may be further processed or packaged in Hong Kong before reexportation. Since 1991, Hong Kong’s re-exports of Mainland origin involving outward processing exceeded Hong Kong’s domestic exports. In 2000, Hong Kong’s re-exports of Mainland origin involving outward processing were US$83 bn, which was 85 per cent of Hong Kong’s re-exports of Mainland origin, or 3.6 times Hong Kong’s domestic exports. The industrial base that Hong Kong firms have established in the Mainland is much larger than that in Hong Kong.

Table 4.6 Hong Kong’s trade involving outward processing in the Mainland since 1989 (US$ m.) (i) Proportion of outward-processing trade in total (percentages). (ii) Growth rate (per cent) over previous year. Trade involving outward processing in China Exports to China

Domestic exports 4098 (76.0) 4676 (79.0) (14.1) 5195 (76.5) (11.1) 5719 (74.3) (10.1) 5835 (74.0) (2.0) 5429 (71.4) (-7.0) 5673 (71.4) (4.5)

Re-exports

Total

China

Guangdong

5 757 (43.6) 7 125 (50.3) (23.8) 9 466 (48.2) (32.9) 12 578 (46.2) (32.9) 14 870 (42.1) (18.2) 18 015 (43.3) (17.0) 22 456 (45.4) (24.7)

9 855 (53.0) 11 800 (58.8) (19.7) 14 661 (55.5) (24.3) 18 297 (52.4) (24.8) 20 706 (47.9) (13.1) 23 444 (47.7) (13.2) 28 130 (49.0) (20.0)

14 562 (58.1) 18 629 (61.8) (27.9) 25 400 (67.6) (36.4) 32 566 (72.1) (28.2) 38 160 (73.8) (17.2) 45 925 (75.9) (20.4) 51 650 (74.4) (12.5)

13 601 – 17 592 – (29.3) 24 011 – (36.5) 30 335 – (26.3) 35 617 – (17.4) 43 372 – (21.8) 49 068 – (13.1)

Re-exports of China origin

Hong Kong domestic exports

–

28 731

–

28 999 – (0.9) 29 732 – (2.5) 30 245 – (1.7) 28 815 – (-4.7) 28 739 – (-0.3) 29 945 – (4.2)

28 497 (74.1) – 38 733 (78.3) (35.9) 47 122 (80.8) (21.7) 54 677 (82.0) (16.0) 63 658 (82.2) (16.4)

89

1989 (i) 1990 (i) (ii) 1991 (i) (ii) 1992 (i) (ii) 1993 (i) (ii) 1994 (i) (ii) 1995 (i) (ii)

Imports from

Table 4.6 Continued

Exports to China

1996 (i) (ii) 1997 (i) (ii) 1998 (i) (ii) 1999 (i) (ii) 2000 (i) (ii) 2001 (i) (ii) 2002 (i) (ii) 2003 (i) (ii)

90

Trade involving outward processing in China Imports from

Domestic exports

Re-exports

Total

China

Guangdong

5571 (72.8) (-1.8) 6081 (76.1) (9.2) 5447 (77.4) (-10.4) 4859 75.9 (-10.8) 5039 (72.7) (3.7) 4509 (71.0) (-10.5) 3670 (69.7) (-18.6) 3201 (68.0) (-12.8)

23 175 (43.2) (3.2) 25 550 (44.7) (10.2) 23 123 (44.1) (-9.5) 25 508 49.7 (10.3) 31 145 (49.7) (22.1) 28 767 (45.2) (-7.6) 31 502 (43.3) (4.5) 38 683 (42.7) (22.8)

28 746 (46.9) (2.2) 31 630 (48.6) (10.0) 28 570 (48.1) (-9.7) 30 367 52.6 (6.3) 36 184 (52.0) (19.2) 33 276 (47.5) (-8.0) 35 173 (45.1) (5.7) 41 884 (43.9) (19.1)

58 558 (79.9) (13.4) 63 439 (81.2) (8.3) 61 684 (82.7) (-2.8) 62 839 80.5 (1.9) 72 692 (79.3) (15.7) 68 200 (78.0) (-6.2) 67 350 (73.8) (-1.2) 72 556 (71.7) (7.7)

55 698 – (13.5) 59 890 – (7.5) 59 971 – (0.1) 60 985 – (1.7) 69 712 – (14.3) 66 788 – (-4.2) 65 497 – (-1.9) 69 966 – (6.8)

Source: Hong Kong External Trade, Census and Statistics Department, Hong Kong, various issues.

Re-exports of China origin 71 479 (86.0) (12.3) 76 920 (88.4) (7.6) 72 269 (87.6) (-6.0) 73 489 (86.6) (1.7) 82 992 (85.1) (12.9) 74 145 (82.2) (-10.7) 75 748 (82.5) (2.2) 77 496 (79.4) (2.3)

Hong Kong domestic exports 27 432 – (-8.4) 27 307 – (-0.5) 24 332 – (-10.9) 21 990 – (-9.6) 23 201 – (5.5) 19 682 – (-15.2) 16 785 – (-14.7) 15 627 – (-7.4)


Around 70 per cent of Hong Kong’s domestic exports to the Mainland are related to outward processing, though this percentage has declined somewhat in recent years because the Mainland has imported more final goods as a result of import liberalization. The share of reexports to the Mainland related to outward processing has declined from the peak of 50 per cent in 1999 to 43 per cent in 2003. This is again due to import liberalization of the Mainland.

Major commodities traded and outward processing As over 90 per cent of Hong Kong’s imports from the Mainland are reexported, the commodity compositions of imports from the Mainland and of re-exports of Chinese origin should be similar. Another factor is that outward processing trade accounts for the bulk of Hong Kong’s trade with the Mainland. As the major industries of Hong Kong are clothing and textiles, electronics and electrical equipment, and miscellaneous manufactures, the major commodities imported from the Mainland should be outputs of these industries. The major commodities exported to the Mainland should be inputs of these industries; for example, yarn or fabric to be processed into textiles and clothing, and electronic components to be assembled into electronic equipment. The major commodities imported from and exported to the Mainland should thus be quite similar. Table 4.7 shows the major commodities in Hong Kong’s trade with the Mainland in 2003. Electronic and electrical equipment, textiles and

Table 4.7 Commodity composition of Hong Kong’s trade with the Mainland, 2003 (percentages) Products are classified by standard international trade classification (SITC); electronic and electrical equipment are groups 75 to 77; textiles and clothing are groups 65 and 84; miscellaneous articles manufactured are group 89.

Electronic and electrical equipment Textiles and clothing Miscellaneous articles manufactured Subtotal

Imports from China

Re-exports of China origin

Re-exports to China

Domestic exports to China

37.3

42.0

50.3

12.3

21.6 11.2

17.1 15.4

10.2 1.7

46.7 6.4

70.1

74.5

62.2

65.4

Source: Review of Overseas Trade 2004, Census and Statistics Department, Hong Kong.

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clothing, and miscellaneous manufactured articles constituted the bulk of Hong Kong’s imports from the Mainland, Hong Kong’s re-exports of the Mainland origin, and also Hong Kong’s domestic exports to the Mainland. For Hong Kong’s re-exports to the Mainland, miscellaneous manufactured articles were not important, but electronic and electrical equipment and also textiles and clothing were important. The main commodities imported from and exported to the Mainland were indeed quite similar. This is because the bulk of Hong Kong’s trade with the Mainland is intra-industry trade (exchanges of commodities within the same industry) generated by Hong Kong’s investment in the Mainland.

The Mainland’s trade with Hong Kong itself The determinants of the Mainland’s trade with third countries via Hong Kong and those of trade with Hong Kong itself are quite different. The former trade is determined by Hong Kong’s efficiency in intermediation and in transportation, the latter by demand and supply conditions in Hong Kong and in the Mainland. The two kinds of trade must therefore be treated separately. Mainland’s trade with Hong Kong itself (excluding the entrepot trade via Hong Kong) is relatively unimportant for the Mainland, representing only 1.8 per cent of the Mainland’s trade in 2002. However, it is important for Hong Kong, as the size of the Hong Kong economy is smaller. Table 4.5 shows that the Mainland’s exports retained for internal use in Hong Kong, which are taken to be Hong Kong’s imports from the Mainland retained for internal use, grew relatively slowly in the reform era. In 2002, though 27 per cent of the Mainland’s exports went to Hong Kong, the bulk were re-exported and only 1.8 per cent of the Mainland’s exports were consumed in Hong Kong. The Mainland has been unable to capture the higher end of Hong Kong’s market, which is dominated by Japan. At present, Japan dominates the market in vehicles, capital goods and quality consumer durables. However, in the long run, the Mainland may be able to upgrade the quality of its consumer goods and capture a bigger part of Hong Kong’s consumer market. While the volumes of Mainland goods retained for internal use in Hong Kong were small relative to the Mainland’s exports in recent years, they continued to be important in Hong Kong’s retained imports because the Hong Kong economy is small. In 2002, Mainland goods retained for internal use in Hong Kong were 10 per cent of Hong Kong’s retained imports. The Mainland was the third supplier of Hong Kong’s retained imports, ranking after Japan and the USA and ahead of Taiwan.


The Mainland’s imports of Hong Kong goods, which are taken to be exports of Hong Kong goods to the Mainland, initially soared with the Mainland’s opening. The share of Hong Kong goods in the Mainland’s imports jumped from an insignificant 0.8 per cent in 1979 to a record of 12.1 per cent in 1990. These were mostly semi-manufactures made and supplied by Hong Kong firms for their subsidiaries in the Mainland. Hong Kong was then China’s third largest supplier after Japan (14.2 per cent) and the USA (12.3 per cent). However, with the liberalization of China’s trade and the jump in Taiwanese investment, Taiwan surpassed Hong Kong and the USA in 1993 to become the second largest supplier, with Hong Kong slipping to fourth. The position of Hong Kong slipped rapidly as a result of the contraction of its manufacturing sector. Hong Kong’s domestic exports to China have declined completely since 1996, and the share of Hong Kong goods in Chinese imports declined to only 1.8 per cent in 2002. Though Hong Kong goods are no longer important in the Mainland’s imports, the Mainland remains a very important market for Hong Kong products, owing to the size of the Mainland market. Since 1993, the Mainland has vied with the USA to be the foremost market of Hong Kong goods, each taking around 30 per cent of Hong Kong’s domestic exports. For 6 of the 11 years from 1993 to 2003, the Mainland was the number one market. As the Mainland–Hong Kong CEPA has granted tariff exemption to Hong Kong goods since 2004, the Mainland is likely to surpass the USA to become the number one market for Hong Kong goods.

The Mainland’s trade with third economies via Hong Kong As mentioned before, Hong Kong’s Mainland-related entrepot trade increased extremely rapidly from 1979 to 1996, but has slowed down since 1996. Around a third of this was traditional or pure entrepot trade, where the Hong Kong trader acts as a middleman, and the rest was related to Hong Kong’s outward processing activities in the Mainland. As a result of the rapid growth of Mainland-related entrepot trade, Hong Kong re-exports surpassed its domestic exports in 1988, and reexports accounted for around 90 per cent of Hong Kong’s total exports in 2003. The Mainland has always been the foremost source of Hong Kong’s re-exports. Since 1980, the Mainland also became the foremost market for Hong Kong re-exports. In 2003, Mainland-related entrepot trade constituted 91 per cent of Hong Kong’s entrepot trade, and 47 per cent of Hong Kong’s total trade.

94


Mainland’s exports re-exported elsewhere via Hong Kong In contrast to the stagnation of the Mainland’s exports retained in Hong Kong in the open-door era, the growth in the Mainland’s exports reexported via Hong Kong was extremely rapid till the mid-1990s. The share of the Mainland’s exports re-exported elsewhere via Hong Kong rose from 7.3 per cent in 1979 to a record of close to 50 per cent in 1993, but declined to 22 per cent in 2003. The rise in the share of Mainland exports re-exported via Hong Kong till the mid-1990s is clearly related to outward processing. Table 4.6 shows that outward processing trade dominated Hong Kong’s re-exports of Mainland origin. However, Table 4.6 also shows that the rate of growth of these Hong Kong’s re-exports of Mainland origin related to outward processing have slowed down from nearly 36 per cent in 1992 to 7.6 per cent in 1997. As a result of the diversion of these exports to Shenzhen ports, the level of these re-exports in 2003 was still beneath that in 1997. Mainland’s imports from elsewhere via Hong Kong With China’s opening, the share of the Mainland’s imports imported via Hong Kong (in the form of Hong Kong re-exports) rose from an insignificant 0.5 per cent in 1977 to a record of 41.3 per cent in 1996 (Table 4.5). Outward processing played an important, but less than dominant, role in the Mainland’s imports of Hong re-exports: the proportion of Hong Kong’s re-exports to the Mainland related to outward processing has been less than half since 1991 (Table 4.6). Pure entrepot trade constitutes the bulk of the Mainland’s imports via Hong Kong. This confirms the importance of Hong Kong for the Mainland in traditional entrepot trade.

Guangdong’s trade with Hong Kong Guangdong’s trade with Hong Kong is considerable. As mentioned above, Hong Kong’s trade with the Mainland is dominated by outward processing trade, and Guangdong accounts for the bulk of this trade. As a result, Guangdong’s trade with Hong Kong accounted for the bulk of Guangdong’s trade as well as Hong Kong’s trade with the Mainland. For instance, in 2002, Hong Kong imports from Guangdong involving outward processing were US$70 bn (Table 4.6), accounting for over 96 per cent of Hong Kong’s imports from the Mainland involving outward processing, and for 72 per cent of Hong Kong’s total imports from the


Mainland. It also accounted for over 55 per cent of Guangdong’s exports. Besides outward processing trade, Guangdong’s trade with Hong Kong not related to outward processing should also be considerable, owing to cultural and geographic proximity.

The Hong Kong–Guangdong production network As the bulk of Hong Kong’s manufacturing has relocated to Guangdong, Hong Kong’s domestic exports are much smaller than the exports of Hong Kong firms in Guangdong. In other words, exports that are made in Hong Kong are much smaller than exports that are made by Hong Kong. As Hong Kong’s production network in Guangdong is huge and its exports have important impacts on world trade, it is worthwhile to estimate the size, the rate of growth, and the market and commodity composition of exports made by Hong Kong. In 2002, Hong Kong manufacturers reportedly employed 10 million workers in Guangdong (Federation of Hong Kong Industries 2003:18) and only 232 700 workers in Hong Kong. Hong Kong’s industrial network in Guangdong is much bigger than that in Hong Kong. Hong Kong’s re-exports involving outward processing in Guangdong are used as a proxy for the exports of Hong Kong firms in Guangdong.3 Guangdong accounted for the great bulk of Hong Kong’s trade involving outward processing in the Mainland (Table 4.6), as Hong Kong’s imports from Guangdong related to outward processing accounted for 93 to 98 per cent of such imports from the Mainland from 1989 to 2003. Hong Kong’s survey of outward processing trade obtained data only on imports from Guangdong, not re-exports of Guangdong origin. As most imports involving outward processing were re-exported, it is reasonable to assume that, in outward processing trade, the shares of Guangdong in Hong Kong’s imports from the Mainland and in reexports of Mainland origin were the same. Given this assumption, the exports of Hong Kong firms in Guangdong in 2000 will have been US$79.6 bn, or 3.4 times Hong Kong’s domestic exports of US$23.2 bn in the same year. After 2000, the value of Hong Kong’s re-exports related to outward processing in Guangdong would probably understate the exports of Hong Kong firms in Guangdong because the exports of Hong Kong firms in Guangdong were increasingly exported through offshore trade rather than through Hong Kong. In fact, Table 4.6 shows that Hong Kong’s imports from Guangdong related to outward processing peaked in 2000, and declined until 2002.

96


Adjusting for the biases of outward processing trade In view of the importance of outward processing trade, Hong Kong’s trade statistics should be interpreted with care, giving recognition to the special characteristics of outward processing trade. For instance, the share of the Mainland in Hong Kong’s trade is biased upwards, because Hong Kong’s domestic exports of semi-manufactures to the Mainland are reimported into Hong Kong after processing in the Mainland, and may even be re-exported to the Mainland and reimported into Hong Kong a few more times before final export to third countries. The overall growth rate and value of Hong Kong’s exports and imports are thus also biased upwards. From 1978 to 2000, Hong Kong exports have grown very rapidly at an average rate of 13.9 per cent per year. In 1993, Hong Kong overtook Belgium–Luxembourg and Netherlands to become the world’s eighth largest exporter. Hong Kong has slipped to eleventh place since 1999 because of the adverse impact of the Asian financial crisis. Table 4.8 shows the value and the market composition of Hong Kong exports and also the exports of Hong Kong firms in Hong Kong and in Guangdong in 1978 and 2000. It tries to correct for the biases introduced by outward processing trade in Hong Kong’s export value, growth rates, and also the market composition of exports.4 The year 1978 was the start of the reform era. The year 2000 was chosen as the final year because 2001 and 2002 were years of recession owing to the slowdown of the world economy and the terrorist attack of 11 September 2001. Moreover, as mentioned above, estimates of exports of Hong Kong firms in Guangdong would be biased downwards after 2000. The first row in Table 4.8 shows the value, growth rate and market composition of Hong Kong’s domestic exports. Despite the decline of manufacturing in Hong Kong, domestic exports to the Mainland have grown rapidly because Hong Kong firms have supplied their subsidiaries in the Mainland with materials and components made in Hong Kong. Hong Kong’s domestic exports to the Mainland grew from negligible amounts to US$6.9 bn in 2000. Since 1993, China has vied with the USA to be Hong Kong’s foremost market, attracting around 30 per cent of domestic exports. The second row in Table 4.8 shows corresponding statistics for Hong Kong’s domestic exports of final goods (that is, total domestic exports less domestic exports to China involving outward processing, largely semi-manufactured goods). The value and growth rate of domestic exports of final goods are naturally less than those of domestic exports.

Table 4.8 Hong Kong exports and exports of Hong Kong firms in Hong Kong and Guangdong Market share (%) Value (US$ m.) 1978 1. Domestic exports 2. Domestic exports of final goods* 3. Exports of final goods of HK firms in HK and Guandong† 4. Total exports 5. Total exports of final goods‡

2000

Growth rate (%) 1978–2000

USA

China

Japan

EU

78

00

78

00

78

00

78

00

8 690 8 690

23 201 18 162

4.6 3.4

37.2 37.2

30.1 38.4

0.2 0.2

29.9 10.4

4.6 4.6

2.8 3.6

26.7 26.7

18.2 23.2

8 690

97 834

11.6

37.2

34.2

0.2

1.9

4.6

7.6

26.7

22.3

11 507 11 507

201 627 165 443

13.9 12.9

30.3 30.3

23.2 28.3

0.5 0.5

34.5 20.2

7.7 7.7

5.5 6.8

21.7 21.7

15.2 18.6

* Domestic exports of final goods = domestic exports - domestic exports to China involving outward processing. † Exports of final goods of HK firms in HK and Guandong = domestic exports of final goods + 0.96 ¥ re-exports of Chinese origin (except to China) involving outward processing. The share of Guangdong in Hong Kong’s imports from China related to outward processing is 0.96. The market composition of HK’s re-exports of Guandong origin involving outward processing is not available and it is assumed to be the same as that of HK’s re-exports of Chinese origin. For 2000, the former was 73.2 per cent of the latter. ‡ Total exports of final goods = total exports - total exports to China involving outward processing. Source: Hong Kong External Trade, various issues (see Table 4.4 for source).

97

98


More importantly, for domestic exports of final goods, the decline in the market shares of the USA and the EU are less dramatic, and the USA is still Hong Kong’s foremost market with a 2000 market share of 38.4 per cent. The Mainland’s share of 10.4 per cent of Hong Kong’s domestic exports of final goods is quite large. Because of recent liberalization of the Mainland’s imports, Hong Kong exported increasing amounts of final consumer goods to the Mainland. Table 4.6 shows the impact of the Mainland’s import liberalization on Hong Kong’s domestic exports from a different angle: the share of outward processing trade in Hong Kong’s domestic exports to the Mainland has declined since 1998. Despite the Mainland’s import liberalization and the increase in Hong Kong’s domestic exports of final goods to the Mainland, Hong Kong cannot supply a large variety of products to the Mainland because Hong Kong’s manufacturing base is very narrow. Hong Kong specializes in a few light consumer goods industries; namely, clothing, textiles, electronics, toys, plastics and watches. As mentioned before, the share of Hong Kong goods in the Mainland’s imports has declined from the record of 12.1 per cent in 1990 to 3.1 per cent in 2000 (Table 4.5). The third row in Table 4.8 shows the exports of final goods of Hong Kong firms in both Guangdong and Hong Kong. This is equal to the total of domestic exports of final goods and Hong Kong’s re-exports of goods from outward-processing operations in Guangdong, which in turn is 96 per cent5 of Hong Kong’s re-exports of goods from outward processing operations in China. The value and growth rate of exports of final goods of Hong Kong firms are of course much higher than those of domestic exports. More importantly, the USA is the foremost market. The share of the US market declined only slightly from 37 per cent in 1979 to 34.2 per cent in 2000. The share of the Mainland market was only 1.9 per cent. This is biased downwards because it only includes Hong Kong’s domestic exports of final goods to the Mainland. The sales of Hong Kong manufacturers in Guangdong in the Mainland market are excluded due to lack of data. The fourth row in Table 4.8 shows Hong Kong’s total exports, which is the total of domestic exports and re-exports. In 2000, Hong Kong’s total exports to the Mainland were US$69.6 bn, 90 per cent of which were re-exports of third-country goods to the Mainland, the rest being Hong Kong’s domestic exports. The trend of total exports is dominated by that of re-exports. Both the value and growth rate of total exports are very high and the Mainland was the foremost market of Hong Kong’s total exports since 1988.


The fifth row in Table 4.8 shows Hong Kong’s total exports of final goods, which are Hong Kong’s total exports less Hong Kong’s total exports to the Mainland related to outward processing. The adjustment is intended to avoid double counting. Unlike the case of total exports, which shows that the Mainland has replaced the USA as Hong Kong’s foremost market, the USA is still the top market for total exports of final goods. However, the 20 per cent market share of the Mainland in total exports of final goods in 2000 was quite high. To summarize, if we net out trade in semi-manufactures between Hong Kong and the Mainland, the USA and the EU are still the largest market for both Hong Kong products and the exports of Hong Kong firms in Hong Kong and in Guangdong. However, with import liberalization in the Mainland, it too is becoming an important market for final goods. Table 4.9 shows exports of Hong Kong firms in Hong Kong and Guangdong by commodity. Many labour-intensive industries have a major share of their exports produced from outward processing operations in Guangdong. These include travel goods and handbags (99.4 per cent), toys (99.2 per cent), telecommunications and sound recording equipment (94.9 per cent), miscellaneous manufactures (89.6 per cent), office machines and automatic data processing machines (87.8 per cent), and watches and clocks (84.3 per cent). Only three industries have over 20 per cent of their output produced in Hong Kong, namely textiles (20.1 per cent), electrical machinery and appliances (27.8 per cent) and clothing (49.4 per cent). Electrical machinery and appliances still have some output produced in Hong Kong because they are more skillintensive. Textiles and clothing also have a relatively small proportion of their exports produced in Guangdong because exports of textiles and clothing are restricted by quota, and Hong Kong has the largest clothing quota in the world.

The Mainland’s service trade with Hong Kong Hong Kong is a service hub and it has a strong comparative advantage in the export of services. Hong Kong’s exports of services in 2002 were US$43.3 bn, or nearly 27 per cent of its GDP. By comparison, Hong Kong’s domestic exports in the same year were only US$16.8 bn. Hong Kong was the world’s ninth largest services exporter in Asia, second only to Japan. Hong Kong has large surpluses in services trade that finance its deficits in commodity trade. In 2002, Hong Kong’s surplus in services trade was US$18.5 bn, or 11 per cent of its GDP.

100 Table 4.9 Exports of Hong Kong firms in Hong Kong and Guangdong by commodity (US$ m.), 2000 Commodities are ranked in descending order of the shares of exports produced in Guandong. Exports of Hong Kong firms produced in SITC commodity 83 Travel goods and handbags 894 Toys 76 Telecommunications and sound recording equipment 69 Metal manufactures nes 899 Miscellaneous manufactures 75 Office machines and automatic data processing machines 885 Watches and clocks 65 Textiles 77 Electrical machinery and appliances 84 Clothing Subtotal All commodities

Hong Kong*

Guangdong†

19 (0.6) 79 (0.8) 539 (5.1) 197 (8.6) 210 (10.4) 936 (12.2)

2 919‡ (99.4) 9 303 (99.2) 10 065‡ (94.9) 2 106 (91.4) 1 817‡ (89.6) 6 763‡ (87.8)

2 938 (100) 9 382 (100) 10 604 (100) 2 303 (100) 2 027 (100) 7 699 (100)

386 (15.7) 1 175 (20.1) 3 658 (27.8) 9 925 (49.4) 17 124 (22.4) 23 201 (22.6)

2 067 (84.3) 4 659‡ (79.9) 9 486‡ (72.2) 10 181 (50.6) 59 366 (77.6) 79 672 (77.4)

2 453 (100) 5 834 (100) 13 144 (100) 20 106 (100) 76 490 (100) 102 873 (100)

Total

* Hong Kong’s domestic exports. † Re-exports of Guangdong origin involving outward processing (taken to be 96 per cent of re-exports of Chinese origin involving outward processing). ‡ Data on re-exports of Chinese origin involving outward processing are not available for these commodities. They are assumed to be equal to 0.96 ¥ 0.762 ¥ Hong Kong’s reexports of Chinese origin of the respective commodities. The average proportion of outward processing trade in China’s re-exports of China origin for these commodities is 0.762, while 0.96 is the proportion of Guandong in Hong Kong’s outward processing trade with China. Source: Census and Statistics Department of Hong Kong.


As expected, the Mainland is Hong Kong’s foremost partner in services trade. In 2002, the Mainland accounted for respectively 27 and 30 per cent of Hong Kong’s services exports and imports. Hong Kong’s services exports to the Mainland in 2002 were US$12.2 bn, or 8 per cent of Hong Kong’s GDP. This does not include the re-export margin that Hong Kong earns through its Mainland-related entrepot trade, which conceptually represents the export of services. However, such services are embodied in the price of goods sold and thus are recorded in trade statistics as export of goods rather than export of services. The re-export margin of Hong Kong’s Mainland-related entrepot trade in 2002 was US$33.4 bn, or 22 per cent of Hong Kong’s GDP. Table 4.10 shows Hong Kong’s services trade with the Mainland since 1995, the first year that figures for services trade by country were available. The three main items of services trade are related to the movement of goods and people between Hong Kong and the Mainland, namely travel (tourism), trade-related services (including merechanting), and transportation. The largest item in Hong Kong’s services exports to the Mainland was trade-related services (including merechanting), accounting for around 40 per cent of total services exports since 1999. This reflects the rise of Hong Kong’s Mainland-related offshore trade mentioned before. Travel was the second largest services export in 2002, accounting for nearly a third of the total. The Mainland has been the top source of tourist arrivals in Hong Kong since 1997. Tourists from the Mainland increased from a trickle to more than 6.8 million in 2002, accounting for 41 per cent of tourist arrivals. Up to 2002, the Mainland tourists’ expenditure in Hong Kong was less than the reverse flow, owing to the Mainland’s controls on outbound tourism. In 2002, Hong Kong residents made a total of over 55 million person-trips to the Mainland for shopping, leisure and business. Hong Kong visitors accounted for roughly 60 per cent of tourist arrivals as well as tourist expenditure in the Mainland in the 2000s. To redress the deficit in tourism, the Hong Kong government has been trying to persuade the Mainland to liberalize its restrictions on outbound tourism to Hong Kong, with the result that the number of incoming Mainland tourists has risen sharply. The Mainland’s quota on group tours to Hong Kong was first relaxed in 1998 and then abolished in 2002. Hong Kong enjoyed a surplus in tourism in the first quarter of 2003. This was temporarily reversed by SARS in the second quarter, but Hong Kong enjoyed a surplus again from July 2003 onwards. Individual tours from selected Mainland cities to Hong

Table 4.10 Hong Kong’s services trade with the Mainland (US$ m.)

Imports of services

Export of services

1995 (i) (ii) 1996 (i) (ii) 1997 (i) (ii) 1998 (i) (ii) 1999 (i) (ii) 2000 (i) (ii) 2001 (i) (ii) 2002 (i) (ii)

102

(i) Percentage distribution of Hong Kong’s exports or imports of services. (ii) Percentage share to Hong Kong’s GDP.

Total

Transportation

Travel

Trade-related services*

Others

Total

Transportation

Travel

Trade-related services*

Others

5 182 (100) (3.7) 6 005 (100) (3.8) 6 829 (100) (3.9) 8 408 (100) (5.1) 8 227 (100) (5.1) 8 895 (100) (5.3) 9 881 (100) (6.0) 12 213 (100) (7.6)

1624 (31.3) (1.1) 1891 (31.5) (1.2) 2068 (30.3) (1.2) 2259 (26.9) (1.4) 2215 (26.9) (1.4) 2279 (25.6) (1.4) 2235 (22.6) (1.4) 2623 (21.5) (1.6)

1518 (29.3) (1.1) 1685 (28.1) (1.1) 1732 (25.4) (1.0) 1633 (19.4) (1.0) 1535 (18.7) (1.0) 1981 (22.3) (1.2) 2378 (24.1) (1.4) 3850 (31.5) (2.4)

827 (16) (0.6) 1361 (22.7) (0.9) 1723 (25.2) (1.0) 3095 (36.8) (1.9) 3185 (38.7) (2.0) 3743 (42.1) (2.2) 4172 (42.2) (2.5) 4520 (37.0) (2.8)

1213 (23.4) (0.9) 1069 (17.8) (0.7) 1306 (19.1) (0.8) 1420 (16.9) (0.9) 1292 (15.7) (0.8) 892 (10) (0.5) 1097 (11.1) (0.7) 1220 (10.0) (0.8)

6822 (100) (4.8) 6899 (100.1) (4.5) 7901 (100) (4.8) 8000 (100) (5.0) 8039 (100) (4.6) 7677 (100) (4.7) 7709 (100) (4.7) 7805 (100) (4.8)

914 (13.4) (0.6) 970 (14.1) (0.6) 1241 (15.7) (0.7) 1078 (13.5) (0.7) 1335 (16.6) (0.8) 1437 (18.7) (0.9) 1607 (20.8) (1) 1634 (20.9) (1)

4339 (63.6) (3.1) 4488 (65.1) (2.9) 5119 (64.8) (2.9) 5448 (68.6) (3.3) 5372 (66.8) (3.3) 4706 (61.3) (2.8) 4466 (57.9) (2.7) 4193 (53.7) (2.6)

528 (7.7) (0.4) 425 (6.2) (0.3) 424 (5.4) (0.2) 476 (5.9) (0.3) 457 (5.7) (0.3) 611 (8) (0.4) 710 (9.2) (0.4) 975 (12.5) (0.6)

1041 (15.3) (0.7) 1016 (14.7) (0.6) 1117 (14.1) (0.6) 958 (12) (0.6) 875 (10.9) (0.5) 922 (12) (0.6) 926 (12) (0.6) 1003 (12.9) (0.6)

* Merchanting and other trade-related services. Source: Census and Statistics Department, HKSAR.


Kong have been allowed since August 2003, and the measure is expected to bring an additional 4 million Mainland tourists to Hong Kong annually. Hong Kong’s surplus in tourism is projected to rise sharply. The promulgation of individual tours to Hong Kong, plus other measures by Beijing to boost the Hong Kong economy, has reversed investors’ sentiments towards Hong Kong, and Hong Kong’s economy rebounded from the SARS crisis in the third quarter of 2003. Hong Kong is also the foremost gateway for foreigners touring the Mainland. Many foreigners also join package tours of the Mainland organized in Hong Kong. Though the Mainland has established increasingly more direct air links with other countries in the 1980s, the percentage of foreign tourists leaving China via Hong Kong has been increasing since 1982, rising to 55 per cent in 1987. Taiwan lifted its ban on travel to the Mainland in 1987, and this of course led to another jump in the number of foreigners visiting the Mainland via Hong Kong. As the Mainland’s markets in financial, communication, business and personal services are not yet very open, trade in such services is very small. In 2001, the shares of such services in Hong Kong’s services exports to the Mainland were as follows: Financial and insurance services Communication services Other business services Personal services

1.6% 1.1% 3.7% 0.1%

Hong Kong imports of services from the Mainland were dominated by travel, accounting for around 60 per cent of the total. The other items are mostly related to movement of goods and people; namely, transportation and trade-related services. With closer economic integration and the implementation of the Mainland–Hong Kong CEPA in 2004, services trade between Hong Kong and the Mainland will diversify and prosper. Besides financial and business services, there are also many opportunities for personal services. For instance, Hong Kong residents have also travelled to the Mainland for medical treatment because the price of healthcare is lower there. Substantial numbers of Mainland Chinese have also travelled to Hong Kong to seek higher-quality medical treatment. There is also thriving exchange in education. The CEPA will stimulate Hong Kong’s exports of services to the Mainland, as it liberalized market access for 18 services sectors in Hong Kong. While tourism and trade-related


services have grown rapidly, the growth in other services will probably be more gradual, as they tend to be highly regulated in the Mainland.

Prospects for Hong Kong as a middleman in the Mainland’s trade Hong Kong handles around half of the Mainland’s trade in various ways. The income generated from handling Mainland-related trade is huge, accounting for more than a quarter of Hong Kong’s GDP. The recent decline in the share of the Mainland’s trade handled by Hong Kong in the form of re-exports has cast doubts on Hong Kong’s prospect as a middleman in the Mainland’s trade. The Mainland’s entry into the WTO also compounded such doubts. It has been alleged that the Mainland will have much less need for Hong Kong as a middleman after its WTO accession, as WTO membership implies complete opening. In view of such doubts, it is important to examine the basis of Hong Kong’s middleman role. Hong Kong’s prospects as a middleman in the Mainland’s trade is of crucial importance for its economy. Hong Kong as a cargo hub Hong Kong has been the world’s busiest container port for many years. Its airport has also handled the largest volume of international air cargo in the world. In 2003, Hong Kong handled 20 million containers while Shanghai and Shenzhen handled respectively 11.3 million and 10.6 million. However, the 2003 growth rate for container throughput in Hong Kong was only 4.7 per cent, while the growth rates for Shanghai and Shenzhen were both 40 per cent. If present trends continue, Shenzhen and Shanghai will surpass Hong Kong as the world’s busiest container port in the medium term. While Hong Kong is likely to lose its dominance in international shipping in a few years, its dominance in air cargo is likely to endure because it has many more international air links than other Chinese cities. In early 2003, Hong Kong had international air links with 131 cities, while Beijing, Shanghai, and Guangzhou had links with only 44, 27 and 19 cities respectively (Ming Pao, 16 January 2003:A3). A large cargo hub is efficient because it has frequent shipping and air transport schedules and cargo can be dispatched promptly. A port with inadequate freight will not be able to attract ships to dock there. A minimum freight of 1.5 million containers a year is needed for an efficient port. An increase in freight will imply more frequent shipping


schedules, which will in turn attract more freight. Such are the economies of agglomeration. There is a well-known ‘hub and spoke’ pattern in transportation. Small ports do not have enough freight to attract shipping lines from all over the world. They ship their cargo to a nearby hub, which has enough freight to attract many shipping lines. The cargo is then transhipped from the hub to its final destination. Until 1995, Hong Kong was the only large shipping hub in China. Nearly all exports in Guangdong were shipped out of Hong Kong in the form of re-exports or transhipment. Goods in central and northern China were shipped out through Hong Kong or Japan. In 1992, 48 per cent of Shanghai’s container cargo was transhipped via Hong Kong (Sung 1999:8). Shanghai was the first Mainland port to reach the minimum threshold of efficiency (1.5 million containers). The rapid growth in Shanghai’s container throughput is partly attributable to the help of Hutchison Whampoa, Hong Kong’s foremost container operator, which started its joint project to modernize Shanghai’s container terminal in 1993. Shanghai’s container throughput grew from one million in 1993 to 1.59 million in 1995, passing the threshold, and reached 5.6 million in 2000. Central and northern China no longer depend on Hong Kong for transhipment. Guangdong’s ports, especially Yantian in Shenzhen, also grew rapidly. Hutchison Whampoa has invested in nearly every port in Guangdong. Up till 1997, 95 per cent of Guangdong’s cargo was shipped through Hong Kong, as none of Guangdong’s ports reached the minimum throughput for efficiency. However, Yantian’s throughput grew very rapidly with the help of Hutchison Whampoa, handling a total of 2.15 million containers in 2000. At present, Hong Kong is still the largest shipping hub in China. The Hong Kong port is very efficient thanks to its clean customs administration and very frequent shipping schedules. However, as the Hong Kong port has much higher costs than Shenzhen, it is highly likely that Shenzhen will surpass Hong Kong in container throughput in the medium term. Hong Kong has to shift from ocean cargo to air cargo, and also concentrates on developing higher value-added logistics services, in which Hong Kong should have a comparative advantage. Change in Hong Kong’s middleman role With the rapid development of Mainland ports in the late 1990s, Hong Kong’s trading companies have substituted direct shipment from the Mainland or transhipment via Hong Kong for re-exports via Hong Kong.


According to a 1997 survey of Hong Kong companies (Hong Kong Trade Development Council 1998), the growth of Hong Kong’s tradesupporting services that are related directly to physical movement of cargo (for example, shipping, trucking, warehousing) may moderate. However, those trade-supporting services not directly related to the physical movement of cargo (for example, trade finance, insurance) will continue to flourish. The majority of companies interviewed indicated that they intended to maintain their controlling headquarters in Hong Kong and would also continue to arrange trade finance, insurance and arbitration in Hong Kong. Hong Kong is efficient in the provision of trade-related services because there are significant economies of scale and economies of agglomeration in trading activity. Yamamura (1976:184–5) argues that significant economies of scale exist in the production of trading services, as the production of these services usually involves large fixed costs and small or declining marginal costs. In the production of market information, which is part and parcel of intermediation, he argues that considerable costs are involved, and the same market information is useful in many transactions. Moreover, trading firms can also consolidate small orders for efficient use of warehouse and shipping capacities to achieve economy of scale. Traders tend to agglomerate in a city, suggesting that there are significant external economies involved. This implies that once a city acquires a comparative advantage in trade, the advantage feeds upon itself, and more trading firms will come to the city, making the city even more efficient in trade. There are, in fact, external economies on both the demand and supply sides in trade. External economy on the demand side operates through search: an increase in the number of potential trading partners in close proximity in a trading hub facilitates search and makes trade easier. As a result of Mainland foreign trade decentralization in the reform era, the number of trading partners has multiplied rapidly, raising the search cost of trade. This creates a demand for intermediation to lower search costs. A large trading hub can provide intermediary services efficiently because it hosts a large number of traders in close proximity (Sung 1991:30–1). External economies on the production side are also important in trade. Hicks (1969:47–9) observed that an increase in the number of merchants in the trading centre would permit specialization and the division of labour, not only by lowering costs but also by lowering risks. The larger the number of traders, the easier it is to acquire information,


and the easier it is to arrange multilateral contracts or to develop specialized contracts such as insurance and hedging. Lucas (1985) stressed the importance of agglomeration, especially in service industries, because people in the same trade can interact and learn from one another. He called this ‘externality of human capital’. As Hong Kong is the largest hub of China’s trade, smaller hubs will have difficulties competing with it in trade-related services. Hong Kong is still the ideal base for entering the Mainland market.

Conclusion Since the opening of China in 1979, Hong Kong has been transformed from a low-value-added manufacturing centre to a higher-value-added service hub of an industrialized Guangdong through outsourcing. Outsourcing generates gains by reallocating resources from lower-valueadded to higher-value-added uses. The allocative gains of outsourcing for Hong Kong can largely be quantified as the income generated by Hong Kong’s exports of goods and services that are related to the Mainland. It was estimated that the income generated by these exports was 23 per cent of Hong Kong’s GDP in 1995, rising to 32 per cent in 2002. The increase in Mainland-related exports accounted for over 90 per cent of the growth of Hong Kong’s GDP between 1995 and 2002 (Sung 2004). While Hong Kong had benefited a great deal from its Mainland connections, future prospects of growth are uncertain because of the stagnation in Mainland-related entrepot trade, which accounted for over 63 per cent of the income generated by Mainland-related exports in 2002. While Mainland-related services exports have grown rapidly, they accounted for only 31 per cent of the 2002 income generated. Mainland-related services exports have to grow very rapidly to make up for the possible decline of Mainland-related entrepot trade. With the rapid development of port facilities in Guangdong, it is inevitable that Hong Kong will lose out in entrepot trade, especially the portion carried by ocean cargo. Hong Kong has to concentrate in its areas of comparative advantage such as air cargo, logistics services, and trade supporting services not directly related to the physical movement of cargo; namely, intermediation, trade finance and insurance. While Hong Kong’s Mainland-related entrepot trade may stagnate, its Mainland-related offshore trade and services trade have been growing rapidly. Hong Kong’s role as a middleman in Mainland’s trade is still important. There has been a shift from visible to invisible trade, from


re-exports and physical cargo handling to provision of services. However, the shift from entrepot trade to offshore trade implies a substantial decrease for Hong Kong in the rate of value added per dollar of trade, as offshore trade does not use Hong Kong’s port facilities. In other words, in the division of the supply chain between Hong Kong and the Mainland, Hong Kong’s slice of the supply chain is getting thinner while the Mainland’s gets thicker. Fortunately, the rapid growth of Mainland trade implies a bigger cake for all, and it is possible for Hong Kong to make up for the fall in the rate of value added per dollar of trade by an increase in volume. Hong Kong has to upgrade its skills and service quality in logistics and other trade-related services to remain competitive.

5 Hong Kong–Mainland Investments

Since the opening of the Mainland in 1979, Hong Kong has been the Mainland’s foremost external investor. As mentioned before, Hong Kong has been the Mainland’s window to the world since the establishment of the People’s Republic in 1949, and the Mainland has invested heavily in Hong Kong. The Mainland and Hong Kong are increasingly intertwined through investment. While bilateral direct investments are huge, linkage through portfolio investment is only starting to develop, owing to the Mainland’s strict controls on its capital account. However, with the Mainland’s entry to the WTO and liberalization of its capital account, bilateral portfolio investment between the Mainland and Hong Kong is expected to soar. This chapter will examine investment data in both the Mainland and Hong Kong to analyse Hong Kong–Mainland investments. The Mainland’s data on its outward FDI in Hong Kong are not usable, as they are greatly biased downwards because of the Mainland’s foreign exchange controls. The Mainland’s data on its inward FDI have been presented in Chapter 2. Statistics on inward FDI in Hong Kong have been available only since 1994, and statistics on Hong Kong’s outward FDI only since 1998. It is, however, possible to piece together a reasonably accurate picture of Hong Kong–Mainland investments from such data.

Hong Kong’s investment in China Table 5.1 shows Hong Kong’s outward FDI in the Mainland. Mainland figures on inward FDI from Hong Kong are shown in Table 5.2 for comparison. The Mainland was the foremost destination of Hong Kong outward FDI, accounting for 88 per cent of the flow from 1998 to 2002, and around half of the stock in 2002. The bulk of Hong Kong’s 109

110

Table 5.1 Hong Kong’s outward FDI (market value, US$ m.) Figures in brackets represent percentages of total. Flow to

1998 1999 2000 2001 2002 1998–2002

Stock in

Mainland

British Virgin Islands

Subtotal

World

Mainland

British Virgin Islands

Subtotal

World

6 936 (63.5) 10 077 (79.7) 46 307 (87.9) 8 500 (107) 15 936 (103.8) 87 756 (88.2)

2295 (21.0) -1179 (-9.4) 3513 (6.7) -1308 (-16.5) -1590 (-10.4) 1731 (1.7)

9 231 (84.4) 8 898 (30.3) 49 820 (94.6) 7 192 (90.9) 14 346 (93.4) 89 487 (89.9)

10 936 (100) 12 654 (100) 52 667 (100) 7 910 (100) 15 359 (100) 99 526 (100)

70 218 (54.3) 79 564 (44.9) 129 692 (58.7) 108 205 (49.5) 108 077 (49.8) –

25 321 (19.6) 60 731 (34.3) 56 436 (25.5) 73 705 (33.7) 68 718 (31.6) –

95 539 (73.9) 140 295 (79.2) 186 128 (84.2) 181 910 (83.2) 176 795 (81.4) –

129 256 (100) 177 090 (100) 221 013 (100) 218 526 (100) 217 179 (100) –

Source: External Direct Investment Statistics of Hong Kong, Census and Statistics Department, Hong Kong, various issues.

Hong Kong–Mainland Investments 111 Table 5.2 Mainland’s inward FDI (historical cost, US$ m.) Figures in brackets represent percentages share of total. Cumulative flows since 1979 from

Flow from

1998 1999 2000 2001 2002 1998–2002

Hong Kong

World

Hong Kong

World

18 508 (40.7) 16 363 (40.6) 15 500 (38.1) 16 717 (35.7) 17 861 (33.9) 84 949 (37.6)

45 463 (100) 40 319 (100) 40 715 (100) 46 878 (100) 52 743 (100) 226 118 (100)

138 440 (52.1) 154 803 (50.6) 170 303 (49.1) 187 020 (47.5) 204 881 (45.9) –

265 607 (100) 305 926 (100) 346 641 (100) 393 519 (100) 446 262 (100) –

Source: See Table 2.4.

investment in its number two destination, the tax haven of the British Virgin Islands, should also be channelled to the Mainland because the Mainland is by far the largest destination of Hong Kong investment.1 The Mainland and the British Virgin Islands together accounted for around 80 per cent of the stock of Hong Kong’s total outward investment. The Mainland’s statistics show that, in 2002, Hong Kong accounted for 46 per cent of the Mainland’s cumulative FDI since 1979. It is tricky to compare Hong Kong statistics on outward FDI in the Mainland and the Mainland’s statistics on inward FDI from Hong Kong because of differences in statistical systems. Hong Kong statistics since 1998 measure FDI at market value, whereas the Mainland’s statistics are based on historical costs. Though it can be argued that valuation at market value is economically more meaningful, market value can be extremely volatile. For example, as a result of the technology bubble in 2000, the stock of Hong Kong’s outward FDI in the Mainland jumped from US$80 bn in 1999 to US$130 bn in 2000, but fell back to US$108 bn in 2001. Mainland statistics, which show cumulative flows at historical cost, do not exhibit such a blip. Due to the volatility in Hong Kong statistics on outward FDI, it is better to cumulate the flow of Hong Kong’s outward FDI in the


Mainland from 1998 to 2002. The cumulative total was US$87.8 bn, which is quite close to the cumulative total of US$84.9 bn in the Mainland’s statistics. However, in 2002, Hong Kong’s stock of FDI in the Mainland of US$108 bn (at market price) was only 53 per cent of the Mainland’s cumulative total inward FDI from Hong Kong of US$205 bn (at historical cost). If Hong Kong’s FDI in the British Virgin Islands is included, the 2002 stock of Hong Kong’s outward FDI in the Mainland would be US$177 bn, which is not too far below the Mainland’s figure. It is not easy to pinpoint the source of discrepancy in the two sets of statistics. As mentioned in Chapter 2, the large share of Hong Kong in the Mainland’s investment conceals an important intermediary role for Hong Kong, as the investment from subsidiaries of foreign companies in Hong Kong is regarded as investment from Hong Kong. However, this upward bias should apply to both sets of statistics. Perhaps part of the investment intermediated via Hong Kong is not captured in Hong Kong statistics but is reflected in the Mainland statistics. Another possibility is that Hong Kong’s data is collected from a survey of enterprises. Investments from Hong Kong individuals in the Mainland are not covered in the survey, though it is separately estimated because it is known to be important. Perhaps Hong Kong statistics have underestimated the investments of Hong Kong individuals in the Mainland. Though Hong Kong’s investments in the Mainland are likely to be exaggerated, they are certainly considerable. Moreover, Hong Kong is also a very important intermediary in channelling investment to the Mainland.

Evolution of Hong Kong’s investment in the Mainland Hong Kong investment in the Mainland is diversified, ranging from small-scale, labour-intensive operations to large-scale infrastructure projects. For Hong Kong, the primary motivation for investment in the Mainland is economic rather than political. In Hong Kong, most manufacturing firms are small, and they have invested in the Mainland in droves since the mid-1980s. Hong Kong’s big firms are mostly in the service sector (banks, real estate, shipping, aviation), and had not been active investors in the Mainland before Deng’s southern tour of 1992, though some had made donations to the Mainland in return for political goodwill. This was simply because the Mainland investment environment had not been favourable for investors in the service sector. Unlike manufacturing output, which can be exported and sold for foreign exchange, services are usually sold in the domestic market for

Hong Kong–Mainland Investments 113

renminbi, which are not convertible, and the foreign investor has a problem of recouping his investment. Moreover, China did not liberalize foreign investment in services till 1992. Before 1992, instead of investing in China, many of Hong Kong’s big firms invested overseas to diversify their portfolio away from Hong Kong and China as insurance against the planned Chinese takeover. However, investment in alien turf is tricky and many of the investments were not very profitable. With Deng’s southern tour in 1992, many of Hong Kong’s big firms quickly realized the opportunity and they spearheaded the floodtide of external investment in China. Deng’s tour stimulated a wave of investment by major Hong Kong companies, including listed companies such as Cheung Kong, Hutchison Whampoa, Sun Hung Kai Properties, New World, and Kowloon Wharf, in projects ranging from real estate to infrastructure and commerce. Hong Kong’s outward FDI by industry Table 5.3 shows Hong Kong’s outward FDI in the Mainland by industry. In 1998, manufacturing accounted for around a third of the stock of Hong Kong’s investment. Investment holding, real estate and other business services were in second place with a share of close to 28 per cent. Communication was in third place, with close to 11 per cent. Since 1998, the bulk of Hong Kong’s investment went to communication. In 2002, its share of the stock of investment jumped to 40 per cent. The share of manufacturing and investment holdings each slipped to around 22 per cent. With the liberalization of the Mainland’s services after WTO entry and the implementation of the Mainland–Hong Kong CEPA, the share of manufacturing is expected to decline further and the share of services to rise even higher. Hong Kong’s role in loans and bonds Hong Kong’s role in the Mainland’s foreign funds raised through loans and bonds is substantial. Over the last 10 years, the Mainland has raised over US$4 bn in the Hong Kong bond market (out of US$14 bn placed outside the Mainland) (Prasad 2004:54). Hong Kong’s share in the Mainland’s foreign loans is understated in official statistics because Mainland statistics on foreign loans in its ‘utilized foreign capital’ (Table 2.2) only include loans handled by state agencies, excluding the bulk of loans extended to foreign-invested enterprises in the Mainland. According to Mainland statistics, from 1979 to 1997, the Mainland’s utilized foreign loans from Hong Kong amounted to US$4.8 bn, or only 4.2 per cent of the total. Data after 1997

114 The Emergence of Greater China Table 5.3 Hong Kong’s investment in Mainland by industry Figure in italics represent percentage share of total. Stock at end of year

Total Industry Communication Manufacturing Investment holdings* Restaurant and hotel Trade† Construction Others

Outflow in year

1998

2000

2002

1998

2000

2002

70 218

129 692

108 077

6 936

46 308

15 936

7 500 10.7 23 115 32.9 19 564 27.9 1 949 2.8 3 410 4.9 1 564 2.2 8 654 12.3

69 577 53.6 25 410 19.6 19 321 14.9 3 513 2.7 3 000 2.3 769 0.6 5 885 4.5

43 487 40.2 23 923 22.1 23 449 21.7 3 731 3.5 3 308 3.1 769 0.7 7 205 6.7

2744 39.6 1962 28.3 1436 20.7 167 2.4 103 1.5

33 180 71.7 4 769 10.3 3 346 7.2 1 308 2.8 872 1.9 308 0.7 1 859 4.0

11 385 71.4 -397 -2.5 3 923 24.6 308 1.9 397 2.5

‡

385 5.5

‡

‡

* Investment holding, real estate and various business services. † Wholesale, retail and import/export trades. ‡ Less than HK$0.05 billion. Source: External Direct Investment Statistics of Hong Kong, Census and Statistics Department, Hong Kong, various issues.

are not available because the Mainland no longer publishes statistics on loans by source. Hong Kong’s share is small because soft loans from international agencies such as the World Bank constitute a substantial portion of the Mainland’s official foreign loans. A more comprehensive picture of Hong Kong’s role in loans can be obtained from Hong Kong banking statistics. In 1996, Hong Kong’s net claims on non-bank customers in the Mainland amounted to US$7.6 bn. Hong Kong’s financial institutions, including the BOC Group, were important sources for such loans. However, with the increasing availability of loans in China due to the development of China’s financial system, Hong Kong’s net claims on non-bank customers in China decreased rapidly. In June 2000, Hong Kong’s net claims on non-bank


customers in the Mainland turned negative (minus US$552 m.), and increased to negative US$6.2 bn by the end of 2003. Hong Kong’s banks played a leading role in syndicating loans to China. Among China’s commercial loans, 70 per cent were syndicated loans and over 60 per cent were syndicated in Hong Kong in the early 1990s (Sung 1998:111). The BOC Group first participated in Hong Kong’s international syndicated loan market in 1979, and has since regularly joined hands with multinational banks in syndicating loans to China. At the peak in 1997, syndicated loans to the Mainland arranged by Hong Kong banks totalled US$6.1 bn (Prasad 2004:53). Hong Kong’s role in portfolio investment The interests of international investors in the Mainland rose greatly after Deng’s 1992 southern tour, and Hong Kong became the major funding centre for Chinese firms. A number of Chinese investment funds were established that invested in industries and B shares in Chinese stock markets in the early 1990s. In 1992, China approved the public listing of selective state enterprises in the Hong Kong stock market, and their shares are popularly called H-shares. Besides tapping external funds, listing in Hong Kong also speeds up China’s enterprise reforms, since listed firms have to follow international accounting standards. By the end of May 1997, just before Hong Kong’s reversion in China, the number of H-shares had risen to 24 with a market capitalization of US$6.9 bn, or around 1 per cent of Hong Kong’s stock market. By the end of 2002, the number of H-shares had risen to 73. All but two of the 75 Mainland state-owned enterprises listed abroad at the end of 2002 were listed in Hong Kong, where they raised cumulative funds of US$18.2 bn (Prasad 2004:52). Listed Hong Kong companies controlled by Mainland Chinese shareholders have been active in Hong Kong’s stock market since the 1980s. By May 1997, they numbered around 50, with a market capitalization of US$49 bn, or 10 per cent of Hong Kong’s stock market. A ChinaAffiliated Corporations Index, or Red Chips Index, was introduced by the Hang Seng Bank in 16 June 1997 owing to investor interests in Red Chips. Impact of the Asian financial crisis To sum up, before the Asian financial crisis, Hong Kong’s role as financier was multi-faceted. Besides providing around half of Mainland’s FDI, Hong Kong was an importance source of commercial loans. Hong Kong banks also played a leading role in 60 per cent of Mainland


syndicated loans. H-shares and H-bonds were sold in the Hong Kong market, and the listings of China-affiliated companies (Red Chips) were highly successful from 1996 to mid-1997. However, the Asian financial crisis exposed the weakness of Red Chips and the risks of lending to Chinese enterprises. After the bankruptcy of the Guangdong International Trade and Investment Corporation (GITIC), the second largest corporation owned by Guangdong, in early 1998, syndicated loans to China dried up. The Crisis exposed the weakness in the governance of Red Chip companies, as Mainlandowned firms operating in the freewheeling environment of Hong Kong are difficult to supervise. A series of corruption-related scandals were exposed in 1998. The Red Chip index fell from a peak of nearly 6300 in August 1997 to a low of 882 in 1998, and hovered around the 1000 to 2000 range until mid-2004. H-shares performed almost as badly because the reform of state owned enterprises in China has been disappointing. The index of H-shares fell from the peak of nearly 7500 in 1997 to a low of 1008 in 1998. However, China’s WTO entry and rapid economic development has provided some stimulus, and the index had recovered to around 4000 in mid-2004. Market interests in H-shares and Red Chips have gradually revived thanks to rapid economic development in China. Mainland-affiliated enterprises (including Mainland enterprises and Hong Kong’s Chinaaffiliated enterprises) have continued to raise funds in the Hong Kong stock market. Their share of the market capitalization of the Hong Kong stock market dropped slightly from 17.3 per cent at the end of 1997 to 16.2 per cent at the end of 1998 as a result of the Asian financial crisis, but rose to 27.6 per cent in 2000, and stayed at around 27 per cent until the end of 2002. From 2000 to 2002, they raised US$61.5 bn on the Hong Kong stock market, accounting for roughly half the funds raised in the market. The share is likely to rise further with the intense interest in the Chinese market in 2004. However, the fundamental problem of the governance of state enterprises has yet to be solved, and the problem will continue to have a dampening effect on investor interests. In the long run, the rapid economic development in China and the reform of China’s SOEs will generate a tremendous demand for funds. The Hong Kong financial market has the depth and also the expertise to provide funding for the Mainland. Private enterprises have grown rapidly in China, and they have a better governance structure than SOEs. As more Mainland enterprises, including private enterprises, seek listing in Hong Kong, Hong Kong could become one of the largest stock markets in the world.


Investment of Hong Kong in Guangdong Hong Kong and Guangdong are each the other’s foremost partner in investment. Table 5.4 shows Hong Kong’s investment in Guangdong from 1998 to 2002. Hong Kong’s data on outward FDI in Guangdong are compared with Guangdong’s data on inward FDI from Hong Kong. Hong Kong’s figures are substantially smaller than Guangdong’s. For example, in 2002, the stock of Hong Kong’s outward FDI in Guangdong was US$51 bn (at market value), which was 60 per cent of Guangdong’s cumulative FDI from Hong Kong (at historical cost). The discrepancy can again be attributed to the upward bias in the Mainland’s figures on inward FDI from Hong Kong. As expected, Hong Kong is investing increasingly outside Guangdong. According to Hong Kong data, Guangdong accounted for the bulk of Hong Kong’s stock of outward FDI in the Mainland up to 1999, but since 2000 Guangdong’s share has dropped rapidly to less than half.

Table 5.4 Hong Kong’s investment in Guangdong Hong Kong’s outward FDI in Guangdong

1998 1999 2000 2001 2002

Flow Stock Flow Stock Flow Stock Flow Stock Flow Stock

Guangdong’s inward FDI from Hong Kong

Value (market value, US$ m.)

% of Hong Kong’s outward FDI in Mainland

Value (historical cost, US$ m.)

% of Guangdong’s FDI

% of Hong Kong’s inward FDI in Mainland

5 244 45 628 5 962 47 410 2 423 49 885 4 051 52 013 3 013 51 154

75.5 65.0 59.2 59.6 5.2 38.5 47.7 48.6 18.9 47.3

8 129 57 006 7 339 64 345 7 448 71 793 7 087 78 880 6 979 85 942

67.6 76.1 63.0 74.7 66.0 73.7 59.4 72.1 61.6 71.2

43.9 40.9 45.0 41.6 48.1 42.2 42.4 42.2 39.1 41.9

Sources: Data for Hong Kong’s outward FDI come from External Direct Investment Statistics of Hong Kong, Census and Statistics Department, Hong Kong, various issues. Data for Guangdong’s inward FDI come from Guangdong Statistical Yearbook and China Statistical Yearbook, various issues.


Guangdong’s figures showed no such trend. Guangdong’s share of Hong Kong’s cumulative inward FDI in the Mainland was slightly over 40 per cent throughout 1998–2002. However, since 2000, the data of both Hong Kong and Guangdong show that Guangdong accounted for less than half of Hong Kong’s stock of FDI in the Mainland. As expected, Hong Kong accounted for the bulk of FDI in Guangdong, though Hong Kong’s share has declined in recent years. Hong Kong’s share of Guangdong’s stock of FDI declined from 76 per cent in 1998 to 71 per cent in 2002, while Hong Kong’s share of the annual flow declined from 68 per cent in 1998 to 62 per cent in 2002. Despite the decline, Hong Kong was still by far the largest investor in Guangdong. Table 5.5 shows Mainland figures on utilized FDI in Guangdong and in Shanghai, and also Hong Kong’s investment in Guangdong in the open-door era. From 1979 to 2002, Guangdong accounted for 27 per cent of the FDI in China. Hong Kong accounted for 71 per cent of the FDI in Guangdong, and Guangdong accounted for 42 per cent of Hong Kong’s FDI in China. Guangdong had been the leading Chinese province in attracting FDI from 1979 to 2002 until it was surpassed by Jiangsu in 2003. Guangdong’s share of the national total has fluctuated from a peak of close to 42 per cent in 1990 to a low of 21.5 per cent in 2002. Guangdong’s share has usually been high when the investment environment in China has not been so good, and has usually declined with the improvement in the Chinese investment environment as foreign investors spread out from Guangdong to other provinces. In the early years of China’s opening from 1979 to 1985, Guangdong had 38 per cent of the FDI in China, while Shanghai’s share was only 2.3 per cent. This was the period when China had just started to attract foreign investment and there were naturally a lot of problems with the Chinese investment environment. China’s investment environment improved in 1987 after the implementation of the 22-point investment enticement package announced in October 1986. In the late 1980s, Guangdong’s share of China’s FDI declined somewhat and Shanghai’s share rose rapidly, reaching a peak of 13 per cent in 1989, when Guangdong’s share was 34 per cent. However, China’s investment environment suffered heavily from the Tiananmen incident of 1989. Pudong was declared open in early 1990, partly to demonstrate China’s determination to continue its policy of opening and reform, but international investors remained sceptical, and Shanghai’s share dropped to a low of 3 per cent in 1991. In contrast, Guangdong’s share of China’s FDI reached a record high of 42 per cent

119 Table 5.5 Utilized foreign direct investment in China (US$ m.) Figures in brackets represent percentage of the total.

Year 1979–85 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1979–2002

National total

Guangdong

HK in China

HK in Guangdong

Shanghai

4 721 (100) 1 875 (100) 2 314 (100) 3 194 (100) 3 393 (100) 3 487 (100) 4 366 (100) 11 008 (100) 27 511 (100) 33 767 (100) 37 521 (100) 41 726 (100) 45 257 (100) 45 463 (100) 40 319 (100) 40 715 (100) 46 878 (100) 52 743 (100) 446 262 (100)

1 801 (38.1) 723 (38.6) 603 (26.1) 958 (30.0) 1 156 (34.1) 1 460 (41.9) 1 823 (41.8) 3 552 (32.3) 7 498 (27.3) 9 397 (27.8) 10 180 (27.1) 11 624 (27.9) 11 711 (25.9) 12 020 (26.4) 11 658 (28.9) 11 281 (27.7) 11 932 (25.5) 11 334 (21.5) 120 711 (27.0)

3 134 (66.4) 1 001 (53.4) 1 588 (68.6) 2 068 (64.7) 2 037 (60.1) 1 880 (53.9) 2 405 (55.1) 7 507 (68.2) 17 275 (62.8) 19 665 (58.2) 20 060 (53.5) 20 680 (49.6) 20 632 (45.6) 18 508 (40.7) 16 363 (40.6) 15 500 (38.1) 16 717 (35.7) 17 861 (33.9) 204 881 (45.9)

1 583 (33.5) 625 (33.4) 513 (22.2) 775 (24.3) 953 (28.1) 996 (28.6) 1 356 (31.1) 3 069 (27.9) 6 530 (23.7) 7 768 (23.0) 7 973 (21.2) 8 387 (20.1) 8 432 (18.6) 8 129 (17.9) 7 339 (18.2) 7 448 (18.3) 7 087 (15.1) 6 979 (13.2) 85 942 (19.3)

108 (2.3) 148 (7.9) 214 (9.2) 233 (7.3) 442 (13.0) 174 (5.0) 145 (3.3) 481 (4.4) 3 160 (11.5) 2 473 (7.3) 2 893 (7.7) 3 941 (9.4) 4 225 (9.3) 3 602 (7.9) 2 837 (7.0) 3 160 (7.8) 4 292 (9.2) 4 272 (8.1) 36 800 (8.2)

Sources: FDI of Hong Kong in Guangdong: Guangdong Statistical Yearbook, various issues; other data come from Almanac of China’s Foreign Relations and Trade, various issues.


in the same year. This reflected the fact that Guangdong has been able to resist the conservative policies sweeping the rest of China. Deng’s 1992 southern tour led to a dramatic improvement in the investment environment and a quantum jump in FDI, and the share of Guangdong in China’s FDI declined. However, in 2002, Guangdong’s 21.5 per cent share of China’s FDI was still far ahead of Shanghai’s share of 8 per cent. Despite the rebound in Shanghai’s share starting in 1992, Guangdong is still far ahead of Shanghai in FDI. However, Jiangsu surpassed Guangdong in FDI in 2003. The challenge of the Yangzi Delta to Guangdong will be discussed in Chapter 8. As mentioned before, Hong Kong’s investment in Guangdong is very large. It has worldwide impact, especially on the effort of the ASEAN to set up the Northern and Eastern Growth Triangles2 to compete for FDI. While Hong Kong’s investments in Guangdong have dropped in recent years, they are still sizeable. For instance, Guangdong’s inward FDI from Hong Kong in 2002 was US$7 bn. This exceeded the 2002 inward FDI of all economies in the Asia-Pacific except for China (US$52.7 bn), Hong Kong (US$13.7 bn), Japan (US$9.3 bn) and Singapore (US$7.7 bn). Guangdong’s total inward FDI in 2002 was US$11.3 bn, and Guangdong was the third largest host of FDI in Asia-Pacific after China and Hong Kong. The impact of Greater Hong Kong on East Asia and the world is beyond dispute. Distribution of investment in Guangdong by industry According to Guangdong’s figures on cumulative FDI from 1979 to 2002, the distribution of utilized foreign capital in Guangdong by sector is similar to the national pattern, except that the share of manufacturing is even larger, as Guangdong is largely an industrial base. For the cumulative stock from 1979 to 2002, manufacturing was by far the major sector with a share of 68 per cent, while real estate was a distant second with a share of 13 per cent. In recent years, despite the gradual liberalization of services, the share of manufacturing in the annual flow of FDI was still very high at 71 per cent in 2002.

Hong Kong investment: benefits to Hong Kong and the Mainland Hong Kong’s investment in the Mainland has had tremendous benefits for both parties. As mentioned before, Hong Kong’s investment in the Mainland has transformed both economies. By relocating their labourintensive processes to Guangdong, Hong Kong’s small manufacturing


firms were saved from bankruptcy, and they utilized their valuable human capital accumulated in the export of labour-intensive products to build a global factory in Guangdong. Hong Kong was transformed from a low-cost manufacturing centre into the service hub of an industrialized Guangdong. Hong Kong’s investment in the Mainland generated huge trade flows in goods and services. As mentioned before, the income generated by Hong Kong’s Mainland-related exports accounted for nearly a third of Hong Kong’s GDP in 2002, and also accounted for over 90 per cent of the growth of Hong Kong’s GDP from 1995 to 2002 (Sung 2004). Hong Kong’s business network in the Mainland gradually spread beyond export processing to services and infrastructure. Hong Kong’s industrial base in Guangdong fed the growth of Hong Kong’s service providers, and some of them grew to be world-class players. Hong Kong has the world’s biggest and most globalized Chinese companies outside the Mainland, and they have the capability to compete with big multinationals in the Mainland market.

Benefits to the Mainland As mentioned before, in 2003, 55 per cent of the Mainland’s exports were produced by foreign-invested enterprises and another 7.6 per cent came from domestic enterprises undertaking subcontracting work for foreign firms (mostly firms in Hong Kong). In 2002, Hong Kong handled close to 45 per cent of the Mainland’s exports through re-exports or offshore trade (Table 4.3), and the bulk of these exports were produced with the help of Hong Kong investment. In a nutshell, Hong Kong investment is crucial to the Mainland’s spectacular export drive. Besides technology transfer, foreign investment has also been important in the Mainland’s gross domestic capital formation. Though foreign investment and exports have undoubtedly brought tremendous benefits to China, it appears that the remnants of China’s planned system have significantly limited that size of the benefits that would have accrued to China. For instance, in China’s processed exports (from processing operations or from foreign-invested enterprises), it is known that the rate of processing margin was 20 per cent or less from 1990 to 1995 (using the value of processed exports as the base), whereas the profit margin and re-export margin earned by Hong Kong was as high as one-third of the value of exports (Sung 2001:217). In China’s processed exports, the ‘take’ of Hong Kong investors/traders was much higher than that of the Chinese manufacturers.


The ‘take’ of Hong Kong was relatively high because Hong Kong performs a lot of value-adding services for processing operations in China, including product design, marketing or order-taking from importers, sourcing, quality control, trade financing, coordination of shipping and so on. Hong Kong investors in China often use transfer pricing to transfer the profits of their subsidiaries back to Hong Kong so as to evade Chinese controls, and such profits also appear as part of the re-export mark-up. The fact that China is dependent on Hong Kong for so many of the above services shows the weakness of the Chinese system. China’s firms are dependent on Hong Kong’s trade financing because of the system of credit rationing in China, which favours state-owned enterprises. China depends on external investors to perform international marketing and order-taking from importers partly because it is cumbersome for Chinese nationals to get passports to travel overseas. Processing operations and foreign-invested enterprises tend to import most of their raw materials because the quality or reliability of local suppliers is less dependable. The rigidity of China’s economic system hampers the development of forward and backward linkages to local enterprises and thus limits the potential benefits of foreign investment. However, the rate of processing margin increased sharply from 21 per cent in 1995 to 34 per cent in 1999 (Sung 2001:217) and rose further to 48 per cent in 2003. This probably indicates that economic reforms have increased the flexibility of the Chinese economy. It also points to an increase in both backward and forward linkages. Initially, processing operations were largely relocated labour-intensive downstream operations. They created a demand for intermediate inputs, which was partly met by the relocation of mid-stream and upstream operations from elsewhere, and also by local enterprises (Naughton 1997:296). This led to an increase in backward linkages. There has also been an increase in forward linkages. As mentioned before, more processed goods have been exported via Mainland ports than via Hong Kong since 1997. The experience of the first-tier Asian NIEs (newly industrializing economies) shows that labour-intensive, export-oriented industrialization is not a blind alley. These economies have been able to upgrade their skills and diversify their exports. Their period of dependence on foreign investors was brief, and they have become important sources of FDI in their own rights. The recent dramatic increase in the rate of processing margin shows that export-oriented industrialization in the Mainland appears to be following the same path as it did in first-tier Asian NIEs.


History of the Mainland’s investment in Hong Kong The Mainland had been an important investor in Hong Kong in the prereform era, because Hong Kong was the Mainland’s gateway to the capitalist world. As mentioned before, Hong Kong was the largest market for the Mainland in the late 1960s and early 1970s. Mainland investment in Hong Kong was designed to enhance the Mainland’s foreign exchange earnings from Hong Kong through exports and remittances. Mainland business interests were represented by four large conglomerates, namely the BOC (Bank of China) and its twelve sister banks, the China Resources Company, the China Merchants Company and the China Travel Service. In the pre-reform era, the Mainland’s investments in HK were conservative. They were designed to handle, transport and finance the Mainland’s exports to HK, and also to handle remittances and visitors. They did not take advantage of local business opportunities. For instance, the BOC Group confined itself largely to China-related trade financing and remittances. The China Resource Company distributed Mainland products, as it was the sole agent of Mainland exports to Hong Kong. The Group has many subsidiaries specializing in retail trade, including China Arts and Crafts, and many department stores selling Chinese products. A pro-China 1981 economic yearbook listed some 1136 sub-agents or wholesalers and 101 department stores specializing in Mainland products (Jao 1983:45). The China Merchants Company shipped China-related trade and the China Travel Service handled overseas visitors visiting China. In support of its propaganda effort, the Mainland had also invested in publishing, bookstores, magazines, news agencies and motion picture production and distribution in Hong Kong. In the reform era, Mainland investment has been much more aggressive, as will be detailed below.

Size of Mainland investment in Hong Kong China has yet to start a regular survey on its outward FDI. The Mainland’s statistics on its outward FDI are highly inaccurate because of the evasion of its foreign exchange controls. The ‘errors and omissions’ item in the Mainland’s balance of payment accounts is large because of illegal capital outflows. According to Mainland estimates, total illegal capital outflows in 1997–9 were between US$48 bn and US$59 bn (Hong Kong Economic Times, 11 July 2001:A17). At the end of 2002, the Mainland’s cumulative approved outward investment overseas and in Hong

124 The Emergence of Greater China Table 5.6 Hong Kong’s inward FDI from the Mainland (i) Percentage share of Hong Kong’s inward FDI. (ii) Percentage share of the Mainland’s outward FDI.

Stock (historical cost)

1994 1995 1996 1997 1998 1999 2000 2001 2002 1998– 2002

Stock (market value)

Inflow

US$ m.

(i)

(ii)

US$ m.

(i)

US $ m.

(i)

12 308 13 782 14 641 18 256 20 846* 25 795* 39 987* 44 923* 49 115* –

18.7 19.6 18.3 19.4 20.3 21.4 26.2 26.0 28.2 –

89.2 87.2 81.7 89.1 94.4 104 155 145 – –

– – – – 27 397 104 462 142 590 122 833 75 859 –

– – – – 21.0 40.1 49.5 43.1 31.2 –

– – – – 2 590 4 949 14 192 4 936 4 192 30 859

– – – – 29.6 27.7 44.5 24.3 242.0 38.3

* Figures obtained by accumulating flows to stock of 1997. Source: External Direct Investment Statistics of Hong Kong, Census and Statistics Department, Hong Kong, various issues.

Kong were only US$9.3 bn and US$4 bn respectively (Editorial Brand of the Almanac of China’s Foreign Relations and Trade 2003:973). Hong Kong statistics on inward DI from the Mainland (Table 5.6) are more accurate. The data were obtained from surveys starting in 1994. The 1994–7 surveys value the stock of inward FDI at historical cost while the 1998–2002 surveys value the stock of inward FDI at market value. As mentioned before, market value can be extremely volatile. For instance, the market value of the stock of inward DI from the Mainland in Hong Kong jumped nearly fourfold from US$27.4 bn in 1998 to US$104.5 bn in 1999. However, 71 per cent of the jump was due to the rise in price of one single telecommunications stock! As a result, the Mainland’s share of Hong Kong’s FDI also jumped from 21 per cent in 1998 to 40 per cent in 1999. Figures based on historical cost are not only more stable, but also more useful for comparison because FDI statistics collected by the Mainland and Taiwan are based on historical cost. In this book, more reliance is placed on valuation at historical cost. The stocks of Hong Kong’s inward DI from the Mainland at historical cost in 1998 to 2002 are estimated by cumulating the inflows of 1998 to 2002 to the 1997 stock at


historical cost. At the end of 2002, the Mainland’s stock of DI in Hong Kong was US$49.1 bn at historical cost. The Mainland is the first external investor in Hong Kong, with a share of 28.2 per cent. From 1994 to 1997, the UK had been the foremost investor in Hong Kong and the Mainland was in second place. In 1997, the share of the UK in the stock of Hong Kong’s inward FDI was 25.2 per cent while the share of the Mainland was 19.4 per cent. In 1998, the Mainland became the number one investor (21 per cent share) because the investment by the Hong Kong Bank was reclassified as belonging to the Netherlands instead of the UK. The position of the UK slipped to second (15 per cent share) and that of the Netherlands suddenly rose to third (12 per cent share). The position of the UK continued to slip as British companies, which had dominated the highly regulated public utilities sector owing to the favouritism of the colonial government, sold their holdings after the 1997 handover. In terms of 2002 stock at market value, the major investors in Hong Kong were the Mainland, with a share of 31.2 per cent, followed by the tax haven economies of Bermuda, the British Virgin Islands and the Cayman Islands (21.2 per cent), Netherlands (10.8 per cent), the USA (9.8 per cent), Japan (7.4 per cent), Singapore (3.9 per cent) and the UK (2.9 per cent). The Mainland’s investment in Hong Kong is very diversified, covering nearly all sectors of the Hong Kong economy; namely, banking, insurance, entrepot trade, shipping, aviation, real estate and manufacturing. The Mainland’s investment strengthens the ties of Hong Kong to the Mainland and enhances the position of Hong Kong as the gateway to China. The ‘round tripping’ of Mainland capital in Hong Kong (Mainland capital that flows to Hong Kong and then back to the Mainland in order to capture the benefits given to foreign investors) inflates the figures of both Mainland investment in Hong Kong and Hong Kong investment in the Mainland. Unfortunately, the precise amounts are very difficult to estimate.

Mainland’s economic presence in major sectors of Hong Kong’s economy Though there is no detailed breakdown of Mainland FDI in Hong Kong, it is known that the Mainland companies are important in banking, insurance, import/export, shipping, manufacturing, real estate and tourism.


The BOC (Bank of China) and its 12 sister banks have long been the cornerstone of Mainland investment in Hong Kong. The Mainland now has 15 banks in Hong Kong, as the CITIC (China International Trust and Investment Company) acquired the Ka Wah Bank and the China Merchants Group acquired the Union Bank in 1986. The BOC joined the Hong Kong Bank and the Standard Chartered Bank as the third noteissuing bank in Hong Kong in May 1994. The BOC Group is the second largest banking group in Hong Kong after the Hong Kong Bank Group. It had a 22 per cent share of deposits and a 17 per cent share of total banking assets in 2002.3 In terms of banking assets, it was in third place after the Hong Kong Bank Group and the European banks. However, the Japanese banks and the European banks operate as individual banks rather than in consortium. Moreover, they are relatively more active in the offshore market than in the local market. The Hong Kong Bank Group and the BOC Group dominate the local market. The BOC Group has been very innovative. In the 1980s, it pioneered the introduction of deposits in euros, telephone banking and the use of a single passbook for 19 foreign currency deposits. The BOC Group has also established branches in China and has pioneered the introduction of mortgage loans. Much useful information and valuable innovations have been transmitted from the BOC Group to China, thus facilitating the banking and economic reforms in China. On the other hand, the rise of Hong Kong as a financial centre also owes a lot to the modernization and internationalization of the BOC Group. Given the intense trade and investment links between Hong Kong and the Mainland, Mainland’s companies are active in Hong Kong’s market for general insurance. The China Insurance Holdings Company, a subsidiary of the People’s Insurance Company of China, claimed a 20 per cent share of Hong Kong’s market for general insurance (Wang 1994:50). Though the company has been quite successful in general insurance, its share of the market for life insurance is small. Provincial and local authorities also run subsidiary insurance companies in Hong Kong (Shen 1993:436). The Insurance Committee of the Hong Kong Chinese Enterprises Association has a membership of 15 companies. Mainland companies are active in trade, transportation and tourism. In 2002, the Mainland accounted for 42 per cent of Hong Kong’s commodity trade, 41 per cent of Hong Kong’s services trade in travel, and 20 per cent of Hong Kong’s services trade in transportation. The China Resources group has distributed Mainland products in Hong Kong, and handled around 20 per cent of Hong Kong’s trade in


1993 (Liu Qingwen 1994:39–44). Many Mainland companies have invested in shipping, transportation and tourism. The China Merchants Group accounted for around 10 per cent of Hong Kong’s cargo throughput from 1992 to 1994, owning a fleet totalling over 6 million tonnes dead weight and assets of over HK$40 bn in 1994.4 The China Resource Group has a fleet of more than 60 cargo ships (Ni 1994:14). Besides their investments in shipping and transportation, the China Merchants Group, China Resources, the China Travel Service and Guangdong Enterprise also have extensive interests in tourism and hotels. There were 36 Mainland tourism companies in Hong Kong in 1992 and Mainland companies owned 8.3 per cent of the total 33 297 hotel rooms in Hong Kong (Ni 1994:14). Mainland investment in manufacturing is quite modest and the Mainland’s share of the stock of external investment in Hong Kong manufacturing declined from 18 per cent in 1985 to 6.8 per cent in 1997. In 1997, the Mainland was a distant third after Japan (41 per cent) and the USA (21 per cent), and Mainland investment in manufacturing was only 2.4 per cent of total Mainland investment in Hong Kong. As Hong Kong is primarily a services centre for the Mainland, and Mainland labour costs are much lower than those of Hong Kong, the modest scale of the Mainland’s involvement in Hong Kong manufacturing is not surprising. As the manufacturing sector is declining rapidly in Hong Kong, data on FDI in manufacturing by source is no longer available after 1997. Mainland companies started to invest in Hong Kong property in the 1980s, starting with the 50-storey headquarters of the Chinese Resource Company. In the late 1980s, the unofficial Mainland companies cashed in on the real estate boom in Hong Kong through speculation, though such practices were prohibited by Beijing. According to one estimate, Mainland investors accounted for 20 to 30 per cent of the property transaction in Hong Kong in 1993 (Ni 1994:12). In the real-estate sector, the Mainland has probably been first among external investors since the early 1990s.

Organization and operation of Mainland companies in Hong Kong Mainland companies are controlled by the Mainland government through the appointment of Mainland cadres to top positions. Some 10 000 PRC (People’s Republic of China) citizens worked in these companies in 1993 (Ni 1994:4). The New China News Agency (NCNA),

128 The Emergence of Greater China Table 5.7 Mainland companies in Hong Kong by supervisory level of government (end of 1993)

State-controlled Provincial-controlled Local-controlled Agent ‘Window’ Military-backed

No. of firms

Supervisory government body

50 72 530 13 300 18

State council and ministries Provinces and municipalities City government or below Various local governments Various military authorities

Source: Ni (1994:5).

China’s de facto embassy in Hong Kong before Hong Kong’s reversion, oversees Chinese companies in Hong Kong. However, the NCNA has not been able effectively to control companies’ links to the military, companies associated with ‘princelings’ (the children of top leaders) and unofficial companies financed by local governments (Ni 1994:4). Some well-known companies affiliated with municipal (city) governments have refused to acknowledge their connections and or to join the Association of Hong Kong Chinese Enterprises (Sung 1996:13). Table 5.7 gives Ni’s estimate of Mainland companies affiliated with various levels of the Chinese government at the end of 1993 (Ni 1994:5). Fifty of the companies are controlled by the State Council or its ministries. Seventy-two companies representing provincial or municipal (city) governments have been officially approved, while an estimated 530 companies affiliated with municipal (city) or local authorities operate unofficially in Hong Kong. Though officially approved companies have been under the purview of the NCNA, provincial or municipal companies have enjoyed a lot more autonomy than state-run companies (Ni 1994:6). They have not needed to remit profits to the central government. It should be noted that companies operated by provincial or municipal governments have sometimes been very large. For instance, Guangdong Enterprises, operated by the Guangdong provincial government, had assets as large as those of CITIC (Hong Kong), amounting to HK$20 bn at the end of 1993. The Yue Xiu Group of the Guangzhou municipal government had assets of HK$5 bn at the end of 1993. Ni estimated that the number of agents functioning as ‘windows’ of local governments in Hong Kong totalled 13 300 (Table 5.7). Ni has apparently assumed that one-third of the 40 000 foreign-invested enterprises in the Mainland owned by Hong Kong functioned as agent ‘windows’ for local governments (Sung 1996:23).

Hong Kong–Mainland Investments 129 Table 5.8 Major princeling companies in HK (known to the public)

Company

Person in charge

CITIC (HK) Continental Mariner (China Poly Group) First Shanghai

Larry Yung Wang Jun He Ping Chen Weili

Ong Group (China Venturetech) Guangdong Investment (Guangdong Enterprises) Laws Property (CNNC)

Chen Weili

Kader Investment

Deng Zifang

CNNC

Wu Jiangchang

Ye Weiping Song Kefong

Family links Son of Rong Yiren, VP of PRC Son of Wang Zhen, VP of PRC Son-in-law of Deng Xiaoping Daughter of Chen Yun, influential leader Daughter of Chen Yun, influential leader Son of Ye Yuanpoing, VP of CPPCC Son of Song Renqun, influential leader The youngest son of Deng Xiaoping The eldest son-in-law of Deng Xiaoping

Source: Ni (1994:8).

Ni estimated that, in 1993, there were 18 companies with military backing operating in Hong Kong, with assets of around HK$10 bn (Ni 1994:7), including the China Poly Group and the China Aerospace Corporation. China Poly Group was founded in 1984 by the military authorities and was the largest arms trader of the People’s Liberation Army (PLA). Its holdings in Hong Kong included interests in shipping and property investment (Ni 1994:21). China Aerospace Corporation specializes in high-tech aerospace products. It manufactures the ‘Long March’ rockets, which launch commercial satellites into orbit. The major ‘princeling companies’ in Hong Kong as listed by Ni are shown in Table 5.8. They include some of the most powerful Mainland companies in Hong Kong such as the CITIC (HK), Laws Property, Continental Mariner of the China Poly Group, Ong Group of the China Venturetech, and Guangdong Investment of Guangdong Enterprises. The business elite of Hong Kong often strengthen their relationship with the Mainland leadership by helping the princelings to acquire listed companies in Hong Kong. For instance, Hong Kong magnate Li Ka-shing joined hands with Deng Zifang, the youngest son of Deng Xiaoping, and the Shougang Corporation to acquire Kader Investment. Mr Xu Jiatun, the former head of the NCNA, makes interesting references to Chinese enterprises in Hong Kong in his memoirs. He com-


plains about the difficulty of managing Chinese companies in Hong Kong that have the personal support of central leaders, especially the princeling companies. Xu remarks that he was powerless to investigate into the irregularities of CITIC (HK), and the China Everbright Company, then under the chairmanship of Wang Guanying, the brother-in-law of former State President Liu Shaoqi (Xu 1993:259–61). Xu knows of around 200 children of high-ranking positions doing business in Hong Kong (Xu 1993:261). He mentions two cases of rampant corruption. In one, Beijing wanted to transfer the person involved back to the Mainland, but he emigrated to Australia. In the other, Xu’s complaints were ignored and the person involved continued to make big money in Hong Kong (Xu 1993:262).

Determinants of Mainland investment in Hong Kong In the open-door era, economic factors are paramount in Mainland investment in Hong Kong, though political factors are still important. Hong Kong is the destination for 80 per cent of the Mainland’s outward investment because Hong Kong is the gateway of the Mainland. Hong Kong’s role as the Mainland’s gateway can be analysed under four main functions (Sung 1991:17): financier, trading partner, middleman and facilitator (Table 5.9). Mainland investment in Hong Kong can be analysed under these functions. Table 5.9 Role of Hong Kong as China’s gateway Financier

Direct investment Indirect investment Loan syndication

Trading partner

Commodity trade Services trade

Middleman

Commodity trade

Entrepot trade Trans-shipment Brokerage in direct trade

Services trade

Tourism Loan syndication Business consultancy

Service centre and facilitator

Contact point Conduit of information and technology Training ground

Marketing Production


Hong Kong as financier Hong Kong accounted for around half of Mainland FDI in the opendoor era. Many Chinese provincial and local authorities have set up offices in Hong Kong to attract foreign investors. As mentioned before, such window companies include 72 official companies, 530 unofficial companies, and thousands of ‘agent’ windows in 1993. From 1984 to 1986, Chinese companies acquired control of three Hong Kong listed companies in rescue operations, namely Conic Investment in 1984 and the Ka Wah and Union banks in 1986. The Chinese strategy was then passive. From 1987 onwards, the Mainland’s strategy changed and the Mainland made active use of Hong Kong’s stock market to tap funds for Mainland enterprises. As new companies do not have the track record to meet the listing criteria of the Hong Kong stock exchange, Mainland companies acquire control of small Hong Kong listed companies and get de facto listing under the shell of the listed companies. In 1987, Guangdong Enterprise acquired Union Globe Development and assumed its listing (Ni 1994:9). Many princeling companies also acquired control of small Hong Kong listed companies, and the prices of their shares usually rose considerably after acquisition, as connection with the Mainland leadership was perceived to be an important asset. For instance, after Deng Zifang, the youngest son of Deng Xiaoping, acquired Kader Investment, the price of its shares rose 30 per cent in one day (United Daily News, Hong Kong, May 20, 1993). In 1992, the three traditional giants among Mainland companies in Hong Kong, namely China Merchants, the China Travel Service and China Resources, reorganized themselves into holding companies and were listed on Hong Kong’s stock exchange. The listings were very successful and the shares of China Merchants were oversubscribed 373 times while those of the China Travel Service were oversubscribed 412 times, setting new records of oversubscription in the Hong Kong stock market. As mentioned before, Red Chips and H-shares have become an important component of the Hong Kong stock market. By May 1997, they constituted well over 10 per cent of the capitalization of the Hong Kong stock market. The BOC group was also listed in 2003. As mentioned before, Hong Kong’s role as financier is multi-faceted. Besides its very important role in direct investment, Hong Kong is also important in loans and in portfolio investment. While investors’ interests in Red Chips and H-shares suffered with the Asian financial crisis, there is still tremendous potential for Hong Kong to develop as a financier for the Mainland in the long run. With the continual listing


of Mainland enterprises in Hong Kong, Hong Kong may become one of the world’s largest stock markets. Hong Kong as trading partner This refers only to the trade involving the Mainland and Hong Kong as final markets (that is, Mainland goods consumed in Hong Kong and Hong Kong goods consumed in the Mainland). The much larger entrepot trade is covered under the middleman function. As mentioned before, though the Mainland has been unable to capture the higher end of Hong Kong’s market, Hong Kong still consumes substantial amounts of Mainland exports – around US$5.7 bn in 2002. This was only 1.8 per cent of Mainland exports (Table 4.5) but still close to 10 per cent of Hong Kong’s retained imports. The China Resource Company had dominant market shares in live and fresh food, toilet tissue, polyester cotton cloth and cotton grey cloth. Its market shares in yarn, petroleum, cement, steel and toy circuits were substantial (China Resources Group 1994:47). Moreover, China has a vast trading and retail network in Hong Kong that was developed in the 1960s and 1970s. Given the change in taste in Hong Kong, the Chinese department stores survived by diversifying their source of consumer products, offering Japanese and European consumer products in addition to Chinese products. The China Resource Company also diversified its operations. Besides its 12 large department stores, it had established a chain of petrol stations and 37 supermarkets by 1992. It has also diversified into banking, financing, energy, transportation, communications, building and construction, manufacturing, real estate and tourism. Services trade between the Mainland and Hong Kong has increased by leaps and bounds in the open-door era. As mentioned in Chapter 4, the Mainland and Hong Kong have each become the other’s foremost source of tourists. It is not surprising that the China Travel Service has expanded its operations tremendously, and other Mainland companies including China Resources, China Merchants and Guangdong Enterprises have also diversified into tourism. Hong Kong as middleman The decentralization of the Mainland system of foreign trade has enhanced the position of Hong Kong as the Mainland’s middleman because decentralization increases the cost of searching for a suitable trading partner. The vast number of window companies and trading firms that the Mainland has established in Hong Kong demonstrate that


the Mainland recognizes the established efficiency of Hong Kong in trading. As Hong Kong is the busiest container port in the world and the dominant transportation hub of the Mainland, it is hardly surprising that Mainland companies have invested heavily in the transportation sector in Hong Kong. For instance, the China Resources Group, the China Merchants Group, the China Travel Service and Guangdong Enterprises have invested heavily in container terminals, shipping, air-freight, aviation and warehouses. Ni observed that ‘almost every Mainland window company has diversified into transportation since 1985’ (Ni 1994:14). Hong Kong as service centre and facilitator The Mainland values Hong Kong as a contact point with the world. Hong Kong is the major centre for the Mainland’s trade and also the centre of consultancy services for businessmen aiming at the Mainland market. Most Mainland companies in Hong Kong, including the window companies, offer consultancy services. The Mainland also values Hong Kong as a conduit of market information and technology transfer. The Mainland has established companies specializing in market information in Hong Kong, including the well-known Southeast Economic Information Centre. China’s investment in Hong Kong manufacturing is often related to technology transfer. In 1985, the Mainland has become the third largest investor in Hong Kong manufacturing after the USA and Japan. For instance, the Mainland has established two relatively high-technology electronics firms in Hong Kong producing integrated circuits. The engineers in these firms come mostly from the Mainland, and these firms have attracted public attention because of an initial US ban, later lifted, on supplying training and equipment to them (Sung 1991:28). The Mainland also uses Hong Kong as a market testing ground to gauge consumer acceptance of its new products through its vast distribution network. Given the economies of agglomeration in most services and Hong Kong’s position as the services centre of China, it is hardly surprising that Mainland companies have invested so heavily in the service sector in Hong Kong.

Political determinants of Chinese investment Before the open-door era, political considerations were important in Mainland investment in Hong Kong. The Communist Party of China initially established businesses in Hong Kong act to as a cover and also


to generate revenue for underground activities (Xu 1993:244). Mainland companies ran five newspapers in Hong Kong as part of the Mainland’s propaganda effort, accounting for one-tenth of the newspaper circulation in Hong Kong. In support of Mainland propaganda effort, the Mainland had invested in publishing, bookstores, magazines, news agencies and motion picture production and distribution. Maintaining Hong Kong’s prosperity during the transition Though economic factors are paramount in the open-door era, political factors are still important. The 1997 crisis has led to the exodus of British capital and Hong Kong Chinese capital. To maintain the prosperity of Hong Kong during its transition to Chinese sovereignty, Xu Jiatun’s proposed strategy was ‘To lure British capital to stay, to stabilize Hong Kong Chinese capital, to promote foreign capital, to foster unity with overseas Chinese capital and Taiwanese capital, and to strengthen Chinese capital’ (Xu 1993:229). The Mainland has actively used its investment in Hong Kong as a vehicle to pursue its goals. ‘To stabilize Hong Kong Chinese capital’, the NCNA has on several occasions asked the BOC to extend loans to friendly Hong Kong magnates in financial crises. The better-known cases include the Hong Kong magnate Fung King Hey (Xu 1993:131–2), the Bank of East Asia (Xu 1993:238) and C.Y. Tung, shipping magnate and father of Tung Chee-hwa, the first chief executive of the Hong Kong Special Administrative Region (HKSAR). The BOC and the NCNA have repeatedly intervened to stabilize financial crises. In 1985, CITIC (Hong Kong) acquired the Ka Wah Bank to avert a crisis. In 1986, the China Merchants Group acquired the insolvent Union Bank. In October 1987, after the worldwide stock market crash, the Hang Seng Futures Exchange was insolvent. The Hong Kong government, the Hong Kong Bank and the BOC mounted a joint rescue operation, and the BOC pledged a loan of HK$100 m. The decision process involved Zhao Ziyang, then premier of China (Xu 1993:198–200). In 1991, rumours caused a run on the Chartered Bank, and the crisis was averted after the Hong Kong Bank and the BOC jointly pledged their support. Interpenetration of economics and politics There was a subtle interpenetration of economics and politics involving Mainland companies in Hong Kong. As an insurance against the uncertainties of 1997, Hong Kong capital has sought allies overseas as


well as in the Mainland. The courtship of Hong Kong magnates and princelings in joint ventures has already been noted. British capital has traditionally dominated the highly regulated sectors of the Hong Kong economy because of the favouritism of the colonial government. These sectors include public utilities, aviation, telecommunication and banking. While banking has been progressively liberalized since the 1970s, the liberalization of the other sectors has only just started. To protect their monopoly rents after 1997, British companies have forged alliances with powerful Mainland companies. For instance, CITIC purchased 25 per cent of Cathay Pacific and 28.5 per cent of Dragonair in 1997. Table 5.10 shows the extensive participation of influential Mainland companies in the regulated infrastructure sectors of Hong Kong at the time of Hong Kong’s reversion in 1997.

Table 5.10 Mainland companies’ stake in the HK infrastructure sector in 1997 Mainland company

Hong Kong company

Infrastructure sector

Share (%)

CITIC/ CITIC Pacific

Cathay Pacific Eastern Harbour Tunnel Western Harbour Tunnel Dragonair HACTL China Light & Power

Aviation services Sea tunnel services Sea tunnel services Aviation services Aviation services Power

25.0 25.0 35.0 28.5 10.0 20.0

CAAC

Jardine Air

40.0

Dragonair

Aviation ground services Aviation services

35.86

China Telecom China Everbright

Hong Kong Telecom Hong Kong Telecom

Telecom services Telecom services

5.5 7.7

China Resources

Modern Terminal

Container harbour services

Tunnel Services

10.0 20.0

China Merchants

Modern Terminal


13.0

COSCO

Container Terminal 8


50.0

China Travel Service

City Bus

Bus

20.0

Source: Updated table based on Ni (1994:13).


The rapid influx of Mainland capital into such sectors may impede their liberalization, as Mainland firms are politically influential.

Future trends Hong Kong’s investment in China appeared to be substantially larger than the reverse flow. Hong Kong’s cumulative direct investment in the Mainland amounted to US$204.9 bn at the end of 2002 (Table 5.4), considerably exceeding Mainland investment in Hong Kong of US$49.1 bn (Table 5.5). However, the estimate of Mainland investment in Hong Kong is likely to be biased downwards because there is an incentive for Mainland’s local authorities and enterprises to establish unofficial subsidiaries in Hong Kong to evade controls on foreign trade and foreign exchange. Hong Kong’s investment in the Mainland is significantly exaggerated as it includes the investment from the subsidiaries of other multinationals incorporated in Hong Kong. Moreover, officials in planned economies tend to exaggerate economic performance (the ‘success indicators’ problem). From anecdotal evidence, it is known that Hong Kong investors often overstate the value of their investments in the Mainland with the connivance of local officials. For example, Hong Kong manufacturers tend to put a high value on the outdated machinery that they move to the Mainland. As the Mainland continues to liberalize its foreign exchange controls, it is expected that more and more Mainland capital will flow to Hong Kong through official as well as unofficial channels. It is natural for Mainland enterprises and investors to move their capital to Hong Kong, as Hong Kong has stricter protection of property rights than the Mainland and the funds can also be used much more flexibly in Hong Kong. In the long run, Mainland investment in Hong Kong may rival Hong Kong’s investment in the Mainland.

6 Trade and Investment Involving Taiwan

As mentioned before, owing to political animosity, policy interactions between Taiwan and the Mainland were mostly not the outcome of direct governmental negotiations. Instead, they were a series of unilateral moves undertaken in anticipation of reciprocal moves by the opposite party. This unique process has achieved remarkable results since 1987 in terms of trade and investment flows. However, as a result of the ascendancy of pro-independence sentiments in Taiwan, Taiwan– Mainland relations have stalled for a decade, since 1994. As Taiwan requires its trade and investment with the Mainland to be conducted indirectly via third territories, both the Mainland’s and Taiwan’s statistics on their trade and investment flows are quite misleading. This chapter will construct the best estimates of Taiwan– Mainland investment and trade flows. Policy issues such as the prospect of direct Taiwan–Mainland links will be discussed in Chapters 8 and 9.

Taiwan’s investment in the Mainland Table 6.1 compares Taiwanese data on investment in the Mainland with Mainland data. As expected, Taiwanese figures are considerably smaller than those of the Mainland because Taiwanese companies that evade the official ban would not report the investment to Taiwanese authorities. The blips in Taiwanese data in 1993, 1997, 1998 and 2002 reflect liberalization of prohibitions that encouraged reporting of investment that had been undertaken before. The cumulative approved investment from 1991 to 2003 totalled US$34.3 bn, which was respectively 94 and 49 per cent of the Mainland’s total of utilized and contracted FDI from Taiwan of US$36.5 bn and US$61.5 bn. 137

138 The Emergence of Greater China Table 6.1 Taiwan’s investment in the Mainland (US$ m.) Figures in brackets represent percentage of Taiwan’s total outward FDI.

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1991–2002 2003 1991–2003

Taiwan data

Mainland data

Approved amount

Contracted FDI

174 (9.5) 247 (21.8) 3 168* (–) 962 (37.3) 1 093 (44.6) 1 229 (36.2) 4 334* (–) 2 035* (–) 1 253 (27.7) 2 607 (33.9) 2 784 (38.8) 6 723* (66.6) 26 610 (43.4) 7 699 34 309

Utilized

1 389

466

5 543

1 051

9 965

3 139

5 395

3 391

5 849

3 162

5 140

3 480

2 925

3 289

2 982

2 915

3 374

2 599

4 042

2 296

6 914

2 980

6 741

3 971

61 471

33 111

8 558 70 029

3 377 36 488

* Data include projects not registered in previous years. Source: Data obtained from website of Investment Commission, Taiwan (www.idic.gov.tw).

According to Taiwanese data, the Mainland is the foremost destination of Taiwan’s outward FDI, with 47 per cent of the cumulative total up to 2003. The USA was a distant second with a 10.4 per cent share.1 Though Mainland figures are more accurate, they also tend to be biased downwards because Taiwanese invest in the Mainland through companies incorporated elsewhere and some Taiwanese investors may

Trade and Investment Involving Taiwan 139

not want to reveal their identity. Mainland figures on Taiwanese FDI also look suspiciously low. For instance, though the size of the Taiwanese economy is nearly twice that of Hong Kong, the total stock of utilized Taiwanese investment at the end of 2003 was only 16 per cent of that of Hong Kong (Table 2.4) according to Mainland figures. As mentioned before, the stock of Hong Kong’s investment is overstated while that of Taiwan is understated. In particular, part of Taiwan’s investment is disguised as Hong Kong investment. Taking into account such biases, there still appears to be a considerable gap between investment from Hong Kong and that from Taiwan. This gap indicates considerable potential for further expansion of the Taiwanese share. However, restrictive Taiwanese policies and the deterioration in Mainland–Taiwan relations since 1994 have slowed down Taiwanese investment. In the early 1990s, Taiwan’s investment was largely in small-scale, labour-intensive operations producing light manufactures for export. The industries included textiles, shoes, umbrellas, travel accessories and electronics, and were concentrated in Fujian (particularly Xiamen) and Guangdong. However, Taiwanese investment has increased in size and sophistication, with an increasing number of more technology-intensive projects such as chemicals, building materials, automobiles and electronic products and components. The fields of investment diversified from manufacturing into real estate, finance, tourism and agriculture. The location of investment also spread inland from the coast. The surge of Taiwanese investment in the Mainland raised fears that such investment would lead to the hollowing out of Taiwan industry and pose a security threat. Taiwan’s government repeatedly tried to cool down the investment boom by improving the investment environment in Taiwan and steering investment away from the Mainland to the ASEAN. For instance, both carrots and sticks were used to prevent Formosa Plastics from implementing its gigantic project to build a naphtha cracking plant in Xiamen. The efforts of the Taiwanese government to steer investment away from the Mainland have not been very successful. Taiwanese companies invest in the Mainland through their overseas subsidiaries, in Hong Kong, in the tax haven economies, or in the USA and Japan. While contracted FDI in the Mainland from Taiwan dropped in 1997 and stagnated in 1998 as a result of the AFC, it has rebounded rapidly since 1999 (Table 2.3). Taiwan’s desktop computer industry relocated to Guangdong in the late 1990s while its notebook (laptop) industry relocated to


Jiangsu in the early 2000s. While the Taiwanese government has not been able to arrest the relocation of production, it tries to encourage Taiwanese companies to maintain their headquarter functions in Taiwan by giving them tax breaks. Taiwan’s investment by region Though Taiwanese figures on outward FDI on the Mainland are grossly understated, its data on the percentage distribution on investment by region (Table 6.2) may be more accurate. The GSC took the bulk of Taiwanese investment, close to 90 per cent in 2003. The share of the GSC in the cumulative total from 1991 to 2003 was nearly 87 per cent. Up until 1999, Guangdong was the foremost destination of Taiwanese investment. The Jiangsu–Shanghai area surpassed Guangdong in 2000. In 2003, the share of Jiangsu–Shanghai was close to half, while Guangdong’s share was only 27 per cent. Jiangsu–Shanghai tends to attract more high-tech investment (for example, notebook computers) as it has more skills. Fujian and Zhejiang were in the third and fourth places, with 9 per cent and 6 per cent of the cumulative investment respectively.

Table 6.2 Taiwan’s approved investment in the Mainland by area (US$ m.) Figures in brackets represent percentage of the total.

Guangdong Jiangsu–Shanghai Fujian Zhejiang

Greater SE China Others Total

1991–2002

2003

Cumulative

8 458 (31.8) 10 484 (39.4) 2 540 (9.6) 1 444 (5.4)

2054 (26.7) 3705 (48.1) 492 (6.4) 611 (7.9)

10 512 (30.6) 14 189 (41.4) 3 032 (8.8) 2 055 (6.0)

22 926 (86.2) 3 684 (13.8) 26 610 (100)

6862 (89.1) 837 (10.8) 7699 (100)

29 788 (86.8) 4 521 (13.2) 34 309 (100)

Source: Investment Commission, Ministry of Economic Affairs, Taiwan.

Trade and Investment Involving Taiwan 141 Table 6.3 Taiwan’s cumulative approved investment by industry (1991 to January 2004)

Industry Agriculture Mining Manufacturing Electronic and electrical appliances Basic metals and products Chemicals Plastic products Precision instruments Food processing Other manufacturing Construction Services Trade Restaurants Transportation Storage Finance and insurance Other services Others Total

Percentage distribution

US$ m. 205 65 31 532

0.56 0.19 90.58 11 206 3 016 2 389 2 349 1 903 1 845 8 854 97

32.19 8.67 6.86 6.75 5.47 5.30 25.35 0.28

2 764

7.94 911 107 137 87 345 1 175

147 34 810

2.62 0.31 0.39 0.25 0.99 3.38 0.42 100

Source: Website of Taiwan’s Investment Commission (www.idic.gov.tw).

Taiwan’s investment by industry Table 6.3 shows Taiwanese cumulative investment in the Mainland up to January 2004 by industry. Unlike the case of Hong Kong, the share of services was small, less than 8 per cent of total investment. Manufacturing accounted for close to 91 per cent of the total. Electronics and electric appliances attracted the most investment, 32 per cent of the cumulative total. Then came basic metals and metal products (8.7 per cent), chemicals (6.9 per cent), plastic products (6.8 per cent), precision instruments (5.5 per cent) and food processing (5.3 per cent). None of the service industries were important.

Taiwan trade with China As in the case of Hong Kong, Taiwan’s investment in China has generated huge trade flows. The bulk of Taiwan’s exports to China consists


of raw materials, semi-manufactures and machinery supplied to Taiwanese enterprises on the Mainland (Kao and Sung 1995:79). Semimanufactures had not been that important in the Mainland’s exports to Taiwan because of Taiwan’s restrictions on such imports in the past. However, the share of semi-manufactures has risen rapidly owing to liberalization of Taiwan’s import controls. Due to Taiwan’s policy of no direct trade, Taiwan–Mainland trade is conducted via third ports, including Hong Kong, Okinawa, Pusan, Guam and Singapore. Both Taiwan and Mainland statistics on Taiwan– Mainland trade are biased downwards because it is not possible to trace the final destination of exports and the true origin of imports through so many third ports. As the bulk of Taiwan–Mainland trade goes through Hong Kong, which has detailed statistics on the origin and destination of re-exports, Hong Kong statistics on re-exports of Taiwanese origin to China and vice versa were often used by researchers to gauge the magnitude of Taiwan–Mainland trade. However, this ignores the substantial direct trade between Taiwan and the Mainland. Undeclared direct exports This trade has arisen from the ingenuity of Taiwanese businessmen in evading Taiwan’s ban on direct trade with the Mainland by the switching of trade documents. Taiwanese exporters claim that their goods are destined for Hong Kong when the goods leave Taiwan. However, before the arrival of the goods in Hong Kong, the trade documents are switched, the goods now being destined for the Mainland. As the goods are consigned to a buyer in the Mainland, they do not go through Hong Kong customs and no Hong Kong firm claims legal possession of the goods. Such goods are transhipped via Hong Kong to the Mainland and they are not regarded as part of Hong Kong’s trade. Table 6.4 shows the phenomenal increase in Taiwan–Mainland transhipment (by weight) via Hong Kong. From 1986 to 2002, transhipment via Hong Kong from Taiwan to the Mainland has grown at the average annual rate of 68 per cent, while transhipment from the Mainland to Taiwan has grown at the average annual rate of 60 per cent. In normal circumstances, the switching of trade documents is not an uncommon practice because of changes in production plans. For instance, a Hong Kong company importing materials from Thailand intended for processing in Hong Kong may later decide to re-route the materials for processing in the Mainland after the shipment has left Thailand but before it has arrived in Hong Kong. However, in the case

143 Table 6.4 Taiwan–Mainland transhipment via Hong Kong (tonnes) Figures in brackets represent percentage share of total transhipment from Taiwan via Hong Kong. From Taiwan to Mainland 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

1 392 (0.5) 1 912 (0.8) 8 096 (3.8) 53 450 (19.4) 81 195 (25.2) 345 700 (52.4) 872 292 (80.7) 1 152 363 (82.1) 1 227 000 (83.7) 1 718 000 (89.6) 1 988 000 (91.2) 2 453 000 (92.8) 2 717 000 (94.1) 3 590 000 (96.0) 4 342 000 (95.1) 5 165 000 (95.1) 5 825 000 (92.6) 5 665 000 (91.1)

From Mainland to Taiwan 800 900 2 595 6 662 12 447 87 610 211 026 329 548 442 000 557 000 626 000 758 000 873 000 962 000 996 000 1 087 000 1 456 000 1 511 000

Sources: Hong Kong Shipping Statistics, Census and Statistics Department, Hong Kong, various issues.


of Taiwan–Mainland trade, the practice of ‘switched bills’ is used on a large scale to evade Taiwan’s ban on direct trade. Taiwan–Mainland trade involving switched bills is called ‘undeclared direct trade’ in this book because it is direct trade in reality (no third party buys the goods involved for resale). This direct trade is not declared to Taiwan authorities. By switching trade documents, the Taiwanese exporters save the fees of going through Hong Kong customs, which amount to 0.1 per cent of the value of the goods involved. This undeclared direct trade also has the advantage of confidentiality because Hong Kong customs does not keep records of transhipment. In terms of transportation, the undeclared direct trade between Taiwan and the Mainland takes three forms, namely, ‘transhipment’, ‘transit shipment’ and ‘illegal direct shipment’. Transhipment involves the uploading and downloading of cargo from one vessel to another, usually in Hong Kong waters. As Taiwan does not permit regular shipping services between Taiwan and the Mainland, transhipment is the dominant mode of undeclared direct trade. The Hong Kong government has statistics on the volume of transhipment by weight but not by value, since transhipped goods do not clear Hong Kong customs. In October 1988, Taiwan allowed any charted ship flying the flag of a third country to sail between the Taiwan Strait as long as it stopped in a third place in its voyage. Taiwanese businesses have chartered ships flying the flags of third countries to carry cargo across the Taiwan Strait without changing vessels. The ships usually stop by Hong Kong and are treated by the Hong Kong government as ‘cargo in transit’. Transit shipment entails considerable savings in money as well as time, as no downloading and uploading is involved. The Hong Kong government does not have statistics on cargo in transit. It is known from press reports and interviews that illegal direct shipment involving chartered ships flying flags of third countries has also occurred. Though illegal direct shipment obviously saves transportation costs, it is risky because shipping records are public information and the Taiwan government can check if the ship has passed through Hong Kong or a third port. There have been cases of ships being fined for illegal direct shipment. In the above three forms of direct trade, Taiwan usually records the exports as destined for Hong Kong. However, the goods are not imported into Hong Kong as they are shipped to the Mainland. Thus, Taiwan’s undeclared direct exports to the Mainland can be estimated from Taiwan’s ‘missing exports’, which are equal to the difference


between Taiwan’s exports to Hong Kong and Hong Kong’s imports from Taiwan after adjusting for the cost of insurance and freight (that is, the difference between c.i.f. and f.o.b. prices). This is an application of the trade-partners statistics techniques; that is, exports (imports) of the home country are estimated from the imports (exports) of trading partners from (to) the home country. Table 6.5 shows the estimation of the value of Taiwan’s missing exports to Hong Kong. Before Taiwan’s liberalization of its Mainland policy in 1987, there were no missing exports and Hong Kong’s imports from Taiwan were slightly larger than Taiwan’s exports to Hong Kong, which represented the normal differential of the cost of insurance and freight. Since 1989, however, Taiwan’s exports to Hong Kong have exceeded Hong Kong’s imports from Taiwan (converted to Taiwan’s f.o.b prices) by an increasingly huge margin. From 1999 to 2002, over half of Taiwan’s exports to Hong Kong were missing. Before 2002, the Mainland Affairs Council of Taiwan regarded all missing exports as undeclared direct exports to the Mainland. However, part of the missing exports may represent Taiwan’s transhipment via Hong Kong to third countries rather than the Mainland. The Foreign Trade Bureau of the Ministry of Economics in Taiwan estimates that 80 per cent of the missing exports go to the Mainland, as this is the estimate given by Taiwanese shippers.2 This 80 per cent estimate is too crude. In fact, from Hong Kong’s transhipment statistics, the share of transhipment to the Mainland in Hong Kong’s transhipment of all goods from Taiwan (by weight) can easily be ascertained. The share was only 19 per cent in 1989, rising rapidly to 95 per cent in 2000 (Table 6.4). The rise is expected as it shows that the practice of using switched bills to disguise exports to the Mainland as exports to Hong Kong had not been so prevalent in 1989, but since has become increasingly widespread. In this book, the share by weight of transhipment to the Mainland in total transhipment from Taiwan is applied to the value of missing exports to estimate the value of undeclared direct exports to the Mainland. Moreover, the estimates of both the Mainland Committee and the Foreign Trade Bureau ignore c.i.f. and f.o.b. price differentials. The estimate used in this book should be the most accurate as it takes into account the share of transhipment to the Mainland in total transhipment from Taiwan as well as c.i.f. and f.o.b. differentials. Such differentials can be considerable for re-exports via Hong Kong because of Hong Kong’s re-export margin.

146 Table 6.5 Taiwan’s exports to Hong Kong and the Mainland (US$ m.) Figures in brackets represent the row percentage distribution of Taiwan’s exports to Hong Kong. Taiwan’s exports to Hong Kong Imported into Hong Kong

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Total

Subtotal

Retained for internal use

5 580 (100) 7 030 (100) 8 570 (100) 12 418 (100) 15 427 (100) 18 455 (100) 21 263 (100) 26 123 (100) 26 788 (100) 28 708 (100) 24 820 (100) 26 028 (100) 31 356 (100) 26 972 (100) 30 845 (100) 28 364 (100)

5 600 (100.4) 6 538 (93.0) 7 377 (86.1) 9 487 (76.4) 11 106 (72.0) 11 991 (65.0) 13 671 (64.3) 16 363 (62.6) 15 628 (58.3) 15 831 (55.1) 13 190 (53.1) 12 621 (48.5) 15 408 (49.1) 13 435 (49.8) 14 310 (46.4) 15 543 (54.8)

3320 (59.5) 3483 (49.5) 3946 (46.0) 4506 (36.3) 4577 (29.7) 4296 (23.3) 5053 (23.8) 6353 (24.3) 5762 (21.5) 5836 (20.3) 4584 (18.5) 4008 (15.4) 4939 (15.8) 3874 (14.4) 3088 (10.0) 2789 (9.8)

Missing exports

China’s imports from Taiwan

–

–

492 (7.0) 1 193 (13.9) 2 931 (23.6) 4 321 (28.0) 6 464 (35.0) 7 592 (35.7) 9 760 (37.4) 11 160 (41.7) 12 877 (44.9) 11 630 (46.8) 13 407 (51.5) 15 948 (50.9) 13 537 (50.2) 16 535 (53.6) 12 821 (45.2)

1 856

Re-exported to China

Elsewhere

2 097 (37.6) 2 712 (38.6) 3 070 (35.8) 4 350 (35.0) 5 882 (38.1) 7 043 (38.2) 7 983 (37.5) 9 260 (35.5) 9 100 (34.0) 9 088 (31.7) 7 821 (31.5) 7 632 (29.3) 8 907 (28.4) 8 181 (30.3) 9 575 (31.0) 10 946 (38.6)

183 (3.3) 343 (4.9) 361 (4.2) 631 (5.1) 647 (4.2) 652 (3.5) 635 (3.0) 750 (2.9) 766 (2.9) 907 (3.2) 784 (3.2) 981 (3.8) 1562 (5.0) 1380 (5.1) 1648 (5.3) 1808 (6.4)

2 254 3 639 5 881 12 933 14 085 14 784 16 182 16 442 16 630 19 528 25 494 27 339 38 063 49 362

Sources: Data for Taiwan’s exports to Hong Kong come from the Monthly Bulletin of Statistics of the Republic of China, Directorate-General of Budget, Accounting and Statistics, Executive Yuan, Republic of China; the amounts imported into Hong Kong are taken to be Hong Kong’s imports from Taiwan (obtained from Hong Kong Review of Overseas Trade, Census and Statistics Department, Hong Kong) times 0.984 to allow for the cost of freight and insurance. Taiwan’s exports re-exported via Hong Kong to China and elsewhere are taken to be Hong Kong’s re-export of Taiwanese goods to China and elsewhere (obtained from Hong Kong Review of Overseas Trade) divided by 1.077 to allow for the re-export mark-up and the cost of insurance and freight. Taiwan’s re-exports retained from internal use in Hong Kong is obtained as a residual. Missing exports are also obtained as a residual. Data from China’s imports from Taiwan come from China Customs Statistics, Economic Information and Agency, Hong Kong.


Declared direct exports Since 1992, Taiwan has accepted switched bills as indirect trade, partly because the government is quite powerless to stop the trade. The Taiwanese government stipulates that cargo in containers should change vessels in a third port (that is, transhipment via a third port). For bulk cargo, transit shipment via a third port is accepted and the changing of vessels is not required because it is expensive and impractical. (For example, Taiwanese businessmen have complained that it is impractical to require the changing of vessel for kaolin, which sticks to the vessel.) Taiwan also encourages exporters to declare their final destination truthfully in order to keep an accurate assessment of the situation. Since 1992, more Taiwanese exporters have declared their exports to the Mainland truthfully, but undeclared direct exports remain substantial. Exports of bulk cargo to the Mainland are more likely to be declared truthfully, as changing of vessel is not involved and it is easy for the authorities to ascertain the final destination of the vessel. Estimation of Taiwan’s exports to the Mainland Table 6.6 shows the estimation of Taiwan’s exports to the Mainland. Column 1 shows declared direct exports as recorded in Taiwan customs statistics. Declared direct exports increased from an insignificant US$1 m. in 1992 to US$21.4 bn in 2003. Column 2 shows undeclared direct exports, which were much larger than declared direct exports until 2002. Column 3 shows total direct exports, which exceeded the indirect exports (column 4) in the form of re-exports via Hong Kong (converted to Taiwan’s f.o.b. prices) since 1996. Column 5 shows total Taiwan exports to the Mainland. For comparison, Table 6.6 also shows the estimates of the Mainland Affairs Council (column 6), the Foreign Trade Board (column 7) and Mainland’s imports from Taiwan in China Customs Statistics (column 8). In comparison with Sung’s estimate, the Mainland Affairs Council overestimated Taiwan’s exports to the Mainland up to 1998 because it regarded all missing exports as undeclared direct exports. Since 1999, the Council’s estimates have been biased downwards because it has ignored Taiwan’s declared direct exports, which became substantial. In 2002, the Council’s adopted the estimates of the Foreign Trade Board. The Foreign Trade Board estimates were biased upwards in the early years (1991–94) but have been biased downwards since 1995 because it mechanically regards 80 per cent of missing exports as undeclared direct exports. The Mainland underestimated its imports from Taiwan up until

148 Table 6.6 Taiwan’s exports to the Mainland (US$ m.) Figures in brackets represent percentage share of Taiwan’s exports. Sung’s estimate

Undeclared (2)

Subtotal (3)

Indirect exports (4)

Total (5)

Mainland Affairs Council estimate (6)

95 (0.1) 301 (0.4) 1 535 (2.0) 3 487 (4.3) 5 309 (6.3) 6 354 (6.8) 8 742 (7.9) 10 177 (8.8) 11 951 (9.8) 10 949 (9.9) 12 873 (10.6) 15 159 (10.2) 12 874 (10.5) 15 311 (11.7) 11 675 (8.1)

95 (0.1) 301 (0.4) 1 535 (2.0) 3 488 (4.3) 5 325 (6.3) 6 486 (7.0) 9 119 (8.2) 10 800 (9.3) 12 579 (10.3) 11 784 (10.7) 15 412 (12.7) 19 379 (13.1) 17 620 (14.3) 25 356 (19.3) 33 092 (22.9)

2 712 (4.1) 3 070 (4.6) 4 350 (5.7) 5 882 (7.2) 7 043 (8.3) 7 983 (8.6) 9 260 (8.3) 9 100 (7.8) 9 088 (7.4) 7 821 (7.1) 7 632 (6.3) 8 907 (6.0) 8 181 (6.7) 9 575 (7.3) 10 946 (7.6)

2 807 (4.2) 3 371 (5.0) 5 885 (7.7) 9 370 (11.5) 12 368 (14.5) 14 469 (15.5) 18 379 (16.5) 19 900 (17.2) 21 667 (17.7) 19 605 (17.7) 23 044 (19.0) 28 286 (19.1) 25 801 (21.0) 34 831 (26.7) 44 038 (30.5)

3 332 (5.0) 4 395 (6.5) 7 494 (9.8) 10 548 (12.9) 13 993 (16.4) 16 023 (17.2) 19 434 (17.4) 20 727 (17.9) 22 455 (18.4) 19 841 (17.9) 21 313 (17.5) 25 030 (16.9) 21 946 (17.9) 29 465 (22.6) 35 358 (24.5)

Direct exports Declared (1) 1989

–

1990

–

1991

–

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

1 (0.0) 16 (0.0) 132 (0.2) 377 (0.3) 623 (0.5) 628 (0.5) 835 (0.8) 2 540 (2.1) 4 220 (2.8) 4 746 (3.9) 9 945 (7.6) 21 417 (14.8)

Board of Foreign Trade estimate (7)

Mainland imports from Taiwan (8)

–

1 856

–

2 254

6 928 (9.1) 9 697 (11.9) 12 728 (15.0) 14 653 (15.7) 17 898 (16.0) 19 148 (16.5) 20 518 (16.8) 18 380 (16.6) 21 221 (17.5) 26 144 (17.6) 24 061 (19.6) 29 465 (22.6) 35 358 (24.5)

3 639 5 881 12 933 14 085 14 784 16 182 16 442 16 630 18 528 25 494 27 339 38 063 49 362

Sources: 1: Taiwan Customs Statistics. 2: See text for method of estimation. 4: Hong Kong’s re-exports of Taiwan origin (from Hong Kong External Trade, Census and Statistics Department, Hong Kong, various issues) less a 7.7 per cent margin to allow for the reexport mark-up and the cost of insurance and freight. 6: Cross-Strait Economic Statistics Monthly, Mainland Affairs Council, Taiwan. 7: Homepage of Board of Foreign Trade, Taiwan (www.trade.gov.tw/prc&hk). 8: China Customs Statistics, Economic Information and Agency, Hong Kong, various issues.


2000 because it failed to identify all of Taiwan’s goods through numerous third ports. However, Mainland statistics have become increasingly accurate. In 2001, the Mainland’s imports from Taiwan were US$27.3 bn. Adjusting for f.o.b./c.i.f. differences, this translates into Taiwan exports of US$26.1 bn, which is 1.3 per cent higher than Sung’s estimate. This shows that Sung’s estimate is quite accurate. While Sung’s estimate is quite accurate, it only takes into account Taiwan’s exports to the Mainland via Hong Kong, ignoring the exports via Okinawa or Korea. It is still biased downwards. Since 2001, Mainland statistics on imports from Taiwan (converted to Taiwanese f.o.b. prices) have been consistently been higher than Sung’s estimate, by 1.3 per cent in 2001, and by 4.8 per cent in 2002. In view of the downward bias in Sung’s methodology, this book uses Sung’s estimates up to 2000, and the Mainland’s statistics on its imports from Taiwan from 2001 onwards (Table 6.8). As mentioned in Chapter 3, Taiwan allowed direct trade and remittances with the Mainland in February 2002 after its WTO entry. This led to a jump in declared direct exports after 2002 (Table 6.6), and a fall in Taiwan’s exports to Hong Kong since 2003 (Table 6.5). Taiwan’s Board of Foreign Trade became worried that, owing to the jump in declared direct exports in 2002, part of declared direct exports would overlap with the indirect exports via Hong Kong, leading to double counting. Since 2002, the Board has deducted an amount of estimated double counting from its original formula.3 However, this adjustment has led to a further downward bias in the estimate. For instance, in 2002, Sung’s estimate was US$34.8 bn. Mainland imports from Taiwan were US$38.1 bn, which translates into Taiwan’s exports of U$36.5 bn after adjusting for f.o.b./c.i.f. price differences. The two estimates are quite close. However, the Board’s 2002 estimate of US$29.5 bn falls short of both estimates by a large margin. In 2003, based on Mainland imports from Taiwan of US$47.4 bn, Taiwan’s exports to the Mainland should be US$47.4 bn. This exceeded the Board’s 2003 estimate of US$35.4 bn by 34 per cent. Taiwan is grossly understating its exports to the Mainland because of faulty methodology. According to the estimate of this book, the Mainland surpassed Japan to become the second largest market for Taiwan (after the USA) in 1992. In 2003, the market shares of Taiwan’s top three markets (Mainland, USA, Japan) in Taiwan’s exports were 32.9, 18.0 and 8.3 per cent respectively. The 2003 market share of Hong Kong was 19.7 per cent according to Taiwan’s statistics, but would only be 1.9 per cent if all goods not retained for internal use in Hong Kong were excluded.


The estimation of the commodity composition of direct exports using the trade-partner statistics technique may not be reliable, as the commodity classification of Taiwan and Hong Kong may not be consistent. However, it is possible to gauge the commodity composition of Taiwan’s exports to the Mainland from China’s import statistics. The main commodities imported by the Mainland from Taiwan in 2003 were: electrical machinery and equipment (34.6 per cent), machinery and mechanical appliances (13.8 per cent), optical, photographic and precision instruments (10.6 per cent), plastics (9.2 per cent) and iron and steel (7.3 per cent). Not surprisingly, many of these were related to Taiwan’s investment in China. Taiwan’s imports from the Mainland Unlike exports, Taiwan’s imports from the Mainland are restricted to selected commodity categories. Prohibited Mainland goods are imported into Taiwan with fake country-of-origin certificates; these can be obtained in Thailand, for example, for a mere US$100. Taiwan’s official statistics on imports from the Mainland are thus biased downwards. As fake country-of-origin certificates are obtainable from many countries, it is very difficult to estimate Taiwan’s imports from the Mainland. Mainland statistics on exports to Taiwan are also biased downwards, as part of Mainland’s exports to Taiwan are regarded by the Mainland as exports to Hong Kong. Before the 1993 reclassification of China Customs Statistics, Taiwan’s total imports from the Mainland can be estimated as follows (Table 6.2): 1. Taiwan’s direct imports (mostly transhipped via Hong Kong) are taken to be Mainland’s exports to Taiwan (converted to Taiwan’s c.i.f. prices) as recorded in China Customs Statistics. 2. Taiwan’s indirect imports are taken to be Hong Kong’s re-exports of Mainland origin to Taiwan (converted to Taiwan’s c.i.f. prices). The sum of the above two items would give Taiwan’s imports from the Mainland. However, since 1993, China’s statistics have vastly overstated the Mainland’s direct exports to Taiwan because the Mainland has tried to reclassify its trade by final destination. The Mainland’s exports to Taiwan include direct exports as well as that part of the Mainland’s indirect exports via Hong Kong known by the Mainland as going to Taiwan. The sum of the above two items would overstate Taiwan’s imports from the Mainland. In Table 6.7, Taiwan’s direct imports since 1993 were estimated from the value of the weight of Hong Kong’s transhipment of Mainland goods

151 Table 6.7 Taiwan’s imports from the Mainland (US$ m.) Figures in brackets represent share of Taiwan’s total imports. Sung’s estimate Direct (1) 1986

–

1987

–

1988

–

1989

96 (0.2) 328 (0.6) 611 (1.0) 716 (1.0) 1090 (1.4) 1506 (1.8) 1986 (1.9) 2282 (2.2) 2778 (2.4) 3117 (3.0) 3334 (3.0) 3428 (2.4) 3676 (3.9) 4429 (3.9) 4303 (3.4)

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Indirect (2)

Total (3)

146 (0.6) 293 (0.8) 486 (1.0) 596 (1.1) 778 (1.4) 1149 (1.8) 1146 (1.6) 1122 (1.5) 1317 (1.5) 1604 (1.6) 1622 (1.6) 1785 (1.6) 1693 (1.6) 1663 (1.5) 2012 (1.4) 1720 (1.6) 1735 (1.5) 2196 (1.7)

146 (0.6) 283 (0.8) 486 (1.0) 692 (1.3) 1106 (2.0) 1760 (2.8) 1862 (2.6) 2212 (2.9) 2823 (3.3) 3590 (3.5) 3904 (3.8) 4563 (4.0) 4810 (4.6) 4997 (4.5) 5440 (4.1) 5396 (5.5) 6158 (5.5) 6499 (5.1)

Taiwan customs statistics (4)

Mainland exports to Taiwan (5)

–

–

–

–

–

–

–

94

–

320

598 (1.0) 747 (1.0) 1 016 (1.3) 1 859 (2.2) 3 091 (3.0) 3 060 (3.0) 3 915 (3.4) 4 111 (3.9) 4 522 (4.1) 6 223 (4.4) 5 902 (5.5) 7 948 (7.1) 10 961 (8.6)

595 698 1462 2242 3098 2803 3397 3869 3950 5040 5000 6586 9005

Sources: 1: See text for method of destination. 2: Hong Kong’s re-exports to Taiwan of Mainland origin (from Hong Kong External Trade, Census and Statistics Department, Hong Kong, various issues) plus a 1.6 per cent margin to allow for the cost of insurance and freight. 4: Cross-Strait Economic Monthly Statistics Monthly, Mainland Affairs Council, Taiwan. 5: China Customs Statistics, Economic Information and Agency, Hong Kong.


to Taiwan. The estimate of the value per tonne of such transhipment is obtained from 1992 data (dividing Taiwan’s 1992 direct imports by the weight of transhipment). The value per tonne in 1992 was US$3392. In subsequent years, the value per tonne is adjusted for inflation using the unit value index of Hong Kong’s imports from China. This method is obviously very crude, but there is no better way of estimation for the 1990s. Table 6.7 shows Taiwan’s imports from the Mainland. The estimated direct imports are in column 1, while the indirect imports in the form of Hong Kong re-exports (converted to Taiwan’s c.i.f. prices) are in column 2. Column 3 shows Taiwan’s total imports. For comparison, Table 6.7 also shows Taiwan’s imports from the Mainland as recorded in Taiwan customs statistics, and Mainland exports to Taiwan as recorded in China customs statistics. In 1999, direct imports were estimated to be US$3.3 bn, which exceeded the indirect imports of US$1.7 bn by a large margin. Between 1995 and 1999, Hong Kong re-exports of Mainland goods to Taiwan stagnated while transhipment of Mainland goods to Taiwan continued to soar (Table 6.4). There is evidently a substitution of direct for indirect trade. Up to 1995, Taiwan’s imports recorded in Taiwan customs statistics were less than the Mainland’s exports to Taiwan. Taiwan’s imports recorded in Taiwan customs statistics are obviously biased downwards, as they were even less than the Mainland’s exports to Taiwan. The latter also have a downward bias, as the Mainland does not have a complete record of its exports to Taiwan through third parties in Hong Kong and other ports. However, Taiwan’s liberalization of imports from the Mainland implies that there is less need to disguise Mainland imports with fake country-of-origin certificates. The rapid growth of Taiwan’s imports in Taiwan customs statistics shows that the downward bias is getting less serious. In 2000, Taiwan’s imports in Taiwan customs statistics exceeded both the estimates of this book and also the Mainland’s exports to Taiwan. As the estimates derived from the weight of transhipment were quite crude, the figure from Taiwan customs statistics should be taken as the best estimate from 2000 onwards. However, the estimate is likely to be slightly biased downwards because Taiwan still banned the import from the Mainland of around 25 per cent of all product items. In 2003, Taiwan’s imports from the Mainland were nearly US$11 bn, or 8.6 per cent of Taiwan’s imports. Taiwan’s imports from the Mainland are much smaller than the reverse flow, but the rate of growth has


been very high. In 2003, the Mainland was the third largest supplier to Taiwan after Japan (25.6 per cent), and the USA (13.2 per cent). The major commodities imported in 2003 were as follows: electrical machinery and equipment (31.1 per cent), machinery and mechanical appliances (22.9 per cent), mineral fuels, oils and products (6 per cent), optical, photographic and precision instruments (4.2 per cent) and iron and steel (3.1 per cent). There is substantial intra-industry trade across the Taiwan Strait and this is one indication that the trade is investmentrelated. Table 6.8 shows Taiwan’s direct and indirect trade with the Mainland. Taiwan has a massive surplus in its commodity trade with the Mainland, partly because of Taiwan’s policy of only importing selected commodity items from the Mainland and partly because of China’s lack of competitiveness in producing items demanded in Taiwan. However, Taiwan has large deficits with the Mainland in tourism, in gifts and remittances, and in investment. The payments balance across the Taiwan Strait is thus more even. Moreover, intra-industry trade is expected to develop rapidly with the surge of Taiwanese investment on the Mainland and the further liberalization of Taiwan’s controls on imports from the Mainland.

China’s commodity trade with Taiwan Table 6.9 gives China’s direct and indirect trade with Taiwan. They are obtained from Table 6.8, adjusting for the difference in f.o.b. and c.i.f. prices, which can be substantial owing to complications in the shipping arrangements and also the re-export margin earned by Hong Kong traders. By 1993, China’s imports from Taiwan constituted 12.6 per cent of its total imports, and Taiwan surpassed Hong Kong and the USA to become the Mainland’s second largest supplier (after Japan). Taiwan’s share of Mainland imports peaked at 16 per cent in 1997, but declined thereafter owing to the very rapid rise in the Mainland’s total imports. With import liberalization, the Mainland’s imports shifted from semimanufactures to consumer goods, and the shift led to a decline in Taiwan’s share because imports from Taiwan were mostly semimanufactures related to Taiwan’s investment in the Mainland. In 2003, the shares of Japan, Taiwan, South Korea and the USA in Mainland’s imports were 18, 12, 10.4 and 8.2 per cent respectively. Taiwan also became a significant market for the Mainland, taking 2.4 per cent of China’s exports.

154 Table 6.8 Taiwan’s direct and indirect trade with the Mainland, 1986–2003 (US$ m.) Figures in brackets represent percentage shares of Taiwan’s total exports/imports. Taiwan’s exports Direct 1986

–

1987

–

1988

–

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

95 (0.1) 301 (0.4) 1 535 (2.0) 3 488 (4.3) 5 325 (6.3) 6 486 (7.0) 9 119 (8.2) 10 800 (9.3) 12 579 (10.3) 11 784 (10.7) 15 412 (12.7) 19 379 (13.1) 17 962 (14.6) 26 931 (20.6) 36 486 (25.3)

Taiwan’s imports

Indirect

Total

753 (1.9) 1 021 (1.9) 2 097 (3.5) 2 712 (4.1) 3 070 (4.6) 4 350 (5.7) 5 882 (7.2) 7 043 (8.3) 7 983 (8.6) 9 260 (8.3) 9 100 (7.8) 9 088 (7.4) 7 821 (7.1) 7 632 (6.3) 8 907 (6.0) 8 181 (6.7) 9 575 (7.3) 10 946 (7.6)

753 (1.9) 1 021 (1.9) 2 097 (3.5) 2 807 (4.2) 3 371 (5.0) 5 885 (7.7) 9 370 (11.5) 12 368 (14.5) 14 469 (15.5) 18 379 (16.5) 19 900 (17.2) 21 667 (17.7) 19 605 (17.7) 23 044 (19.0) 28 286 (19.1) 26 143 (21.3) 36 506 (28.0) 47 432 (32.9)

Direct – – – 96 (0.2) 328 (0.6) 611 (1.0) 716 (1.0) 1090 (1.4) 1506 (1.8) 1986 (1.9) 2282 (2.2) 2778 (2.4) 3117 (3.0) 3334 (3.0) 4211 (3.0) 4200 (3.9) 6213 (5.5) 8766 (6.9)

Indirect

Total

146 (0.6) 293 (0.8) 486 (1.0) 596 (1.1) 778 (1.4) 1149 (1.8) 1146 (1.6) 1122 (1.5) 1317 (1.5) 1604 (1.6) 1622 (1.6) 1785 (1.6) 1693 (1.6) 1663 (1.5) 2012 (1.4) 1720 (1.6) 1735 (1.5) 2196 (1.7)

146 (0.6) 283 (0.8) 486 (1.0) 692 (1.3) 1 106 (2.0) 1 760 (2.8) 1 862 (2.6) 2 212 (2.9) 2 823 (3.3) 3 590 (3.5) 3 904 (3.8) 4 563 (4.0) 4 810 (4.6) 4 997 (4.5) 6 223 (4.4) 5 920 (5.5) 7 948 (7.1) 10 962 (8.6)

Sources: Taiwan’s exports to the Mainland: Sung’s estimates (Table 6.6) are used from 1989 to 2000. Before 1989, direct exports were negligible, and Taiwan’s exports to the Mainland are taken to be its indirect exports via Hong Kong. Since 2001, Taiwan’s total exports are estimated from the Mainland’s imports from Taiwan. Taiwan’s imports from the Mainland: Sung’s estimates (Table 6.7) are used from 1986 to 1989. Since 2000, Taiwan’s total imports are taken from Taiwan Customs Statistics (Table 6.7).

155 Table 6.9 Mainland direct and indirect trade with Taiwan, 1986–2003 (US$ m.) Figures in brackets represent percentage share of China total exports and imports. Imports

Exports

Direct

Indirect

Total

1986

–

1987

–

1988

– 98 (0.2) 309 (0.6) 1 576 (2.5) 3 580 (4.4) 5 467 (5.3) 6 658 (6.0) 9 361 (7.1) 11 086 (8.0) 12 912 (9.1) 12 096 (8.6) 15 821 (9.5)

819 (1.9) 1 111 (2.6) 2 282 (4.1) 2 951 (5.0) 3 340 (6.3) 4 733 (7.4) 6 400 (8.2) 7 663 (7.4) 8 686 (7.5) 10 075 (7.6) 9 901 (7.1) 9 888 (6.9) 7 922 (5.7) 8 304 (5.0)

819 (1.9) 1 111 (2.6) 2 282 (4.1) 3 049 (5.2) 3 649 (6.8) 6 309 (9.9) 9 980 (12.4) 13 130 (12.6) 15 344 (13.7) 19 436 (14.7) 20 987 (15.1) 22 800 (16.0) 20 018 (14.3) 24 125 (14.6)

2000

19 893 (8.8)

9 691 (4.3)

2001

18 438 (7.6) 27 645 (9.4) 37 453 (9.1)

8 901 (3.7) 10 418 (3.5) 11 909 (2.9)

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

2002 2003

Direct –

Indirect

Total

94 (0.2) 320 (0.5) 595 (0.8) 698 (0.8) 1062 (1.2) 1467 (1.2) 1935 (1.3) 2223 (1.5) 2706 (1.5) 3037 (1.7) 3248 (1.7)

126 (0.4) 253 (0.6) 419 (0.9) 514 (1.0) 671 (1.1) 991 (1.4) 988 (1.2) 967 (1.1) 1135 (0.9) 1383 (0.9) 1398 (0.9) 1539 (0.8) 1459 (0.8) 1434 (0.7)

126 (0.4) 253 (0.6) 419 (0.9) 608 (1.2) 991 (1.6) 1 586 (2.2) 1 686 (2.0) 2 029 (2.3) 2 602 (2.2) 3 318 (2.2) 3 621 (2.4) 4 496 (2.3) 4 496 (2.4) 4 682 (2.4)

29 584 (13.1)

4102 (1.6)

1734 (0.7)

5 836 (2.3)

27 339 (11.2) 38 063 (12.9) 49 362 (12.0)

4074 (1.5) 6053 (1.9) 8540 (1.9)

1483 (0.6) 1496 (0.5) 1893 (0.4)

5 557 (2.1) 7 549 (2.3) 10 433 (2.4)

– –

Sources: Estimated from Table 6.8 by adjusting for c.i.f. and f.o.b. price differences: China’s direct imports equal 1.0265* times Taiwan’s direct exports. China’s indirect imports equal 1.088† times Taiwan’s indirect exports. China’s direct exports equal Taiwan’s direct imports divided by 1.0265.* China’s indirect exports equal Taiwan’s indirect imports divided by 1.16.‡ * The f.o.b.–c.i.f. margin for Hong Kong–Mainland trade is 1 per cent. The total margin for direct trade is thus 1.0163 (margin for Hong Kong–Taiwan trade) ¥ 1.01 = 1.0265. † The total margin for indirect imports is 1.0265 (margin for direct trade) ¥ 1.06 (re-exports margin of Taiwanese goods) = 1.088. ‡ The total margin for indirect exports is 1.0265 (margin for direct trade) ¥ 1.13 (re-export margin of mainland goods) = 1.16.


Service trade between the Mainland and Taiwan Both the Mainland and Taiwan are liberalizing their service sectors after WTO entry, and services trade between the Mainland and Taiwan is likely to grow in the long run, especially if direct transportation links are established between the Mainland and Taiwan. However, owing to Taiwan’s existing bans, service trade between China and Taiwan had been largely restricted to Taiwanese tourists visiting China. Nearly 3.7 million Taiwanese tourists visited the Mainland in 2002. Taiwan is the third largest source of tourists into the Mainland after Hong Kong and Macau, accounting for 3.7 per cent of tourist arrivals there in 2002. The Taiwanese share of tourist expenditures in China is likely to be a few times higher than its share in tourist arrivals because, on a per capita basis, the Taiwanese visitor spends much more than short-term visitors from Hong Kong and Macau. Most Taiwanese visiting China do so via Hong Kong. As a result, Taiwan has been among the leading sources of tourists for Hong Kong since 1988. While Mainlanders have been allowed to visit Taiwan since 1988, the numbers have been quite small: 199 000 in 2002 and 188 800 in 2003. As Taiwan has allowed investment from the Mainland in real estate and selected services after Taiwan’s WTO entry, business travellers from the Mainland will now increase.

Trade and investment between Hong Kong and Taiwan Before 1987, economic ties between Hong Kong and Taiwan were onesided because of Taiwan’s trade protectionism and foreign exchange controls. The Hong Kong market was open to Taiwan; Hong Kong investors were free to invest in Taiwan, and Hong Kong tourists were free to go there, but movements in the opposite direction were restricted. Hong Kong was Taiwan’s third largest market (after the USA and Japan) from 1975 to 1990, accounting for roughly 7 per cent of Taiwan’s exports in 1975. However, Hong Kong exports to Taiwan were small owing to Taiwan’s barriers. Since the 1950s, Hong Kong has been the third largest investor in Taiwan after the USA and Japan, but Taiwanese investment in Hong Kong was insignificant. Since the 1960s, Taiwan has been an important destination for Hong Kong tourists, but few Taiwanese tourists had visited Hong Kong, because of Taiwan’s controls on foreign exchange and departures. However, economic ties developed rapidly in the late 1980s with the liberalization of Taiwan’s import and foreign exchange controls, the


sharp appreciation of the Taiwanese currency and Taiwan’s use of Hong Kong as an intermediary in its interactions with China. Many Taiwanese toured Hong Kong on their way to the Mainland, with Taiwan becoming the foremost source of tourists for Hong Kong from 1988 to 1993 (20 per cent of tourist arrivals in 1993). The Mainland surpassed Taiwan as the foremost source of tourists to Hong Kong in 1994. Since then, Taiwan has been the second largest source of tourists to Hong Kong.4 Taiwan has also become a significant investor in Hong Kong. The share of the Taiwan market in Hong Kong’s domestic exports jumped from 1 per cent in 1985 to 3.4 per cent in 2000, but declined marginally to 3 per cent in 2003. Since 1986, Taiwan has been a secondtier market for Hong Kong’s domestic exports, ranking in fifth to seventh place. In 1991, the Mainland surpassed Hong Kong as a final market for Taiwanese products and Hong Kong slipped to fourth place. As a final market, Hong Kong was surpassed by Germany in 2001 and by South Korea in 2002, Hong Kong slipping to sixth place. In 2002, Taiwan’s exports retained for internal use in Hong Kong were US$3.1 bn (Table 6.5) or 2.4 per cent of Taiwan’s exports. Taiwan supplied 5.3 per cent of the total retained imports of Hong Kong in 2002 and was the fourth largest supplier of Hong Kong’s retained imports after Japan, the USA and the Mainland. Hong Kong investment in Taiwan has continued to grow. According to Taiwan’s figures on approved FDI, Hong Kong’s approved FDI in Taiwan by the end of 2000 totalled US$3.6 bn, which was 8 per cent of cumulative inward investment in Taiwan (Table 6.10). Hong Kong was the third investor after the USA, and Japan.5 As for the sectoral composition of Hong Kong’s cumulative investment at the end of 2000, finance and insurance was the largest sector with an 18.2 per cent share, followed by electronic and electrical appliances (15.9 per cent), services (12.3 per cent), trade (8.8 per cent) and chemicals (7.7 per cent).6 Hong Kong’s cumulative approved FDI in Taiwan rose slightly to US$3.8 bn by the end of 2003. Hong Kong has lately started to collect data on outward investment. According to Hong Kong figures (Table 6.11), at the end of 1999, Hong Kong’s stock of outward FDI in Taiwan was only US$731 m. (at market value). However, the stock rose rapidly to US$1.9 bn at the end of 2002. While this was roughly half of Taiwan’s figure, Hong Kong’s figure should be more accurate. Approved FDI is usually biased upwards because not all approved projects are realized. Moreover, accumulation of annual flows would include businesses that have ceased operation.

158 The Emergence of Greater China Table 6.10 Hong Kong’s approved direct investment in Taiwan

1952–1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 1952–2000 2001–2003 1952–2003

Amount (US$ m.)

Taiwan’s total inward investment

Share of Taiwan’s inward FDI (%)

1198 236 129 213 169 251 147 267 237 275 161 271 3552 256 3808

10 950 2 302 1 778 1 461 1 214 1 631 2 925 2 460 4 267 3 739 4 231 7 608 44 566 11 976 56 542

10.9 10.3 7.2 14.6 14.0 15.4 5.0 10.8 5.6 7.3 3.8 3.6 8.0 2.1 6.7

Source: Website of Investment Commission, Ministry of Economic Affairs, Taiwan (www.idic.gov.tw).

Table 6.11 Hong Kong’s outward FDI in Taiwan (US$ m.) Figures in brackets represent percentage shares of Hong Kong’s total outward FDI. Flow 1999 2000 2001 2002

128 (0.10) 256 (0.49) 295 (3.73) 205 (1.34)

Stock 731 (0.41) 846 (0.38) 1525 (0.70) 1923 (0.89)

Source: External Direct Investment Statistics of Hong Kong, Census and Statistics Department, Hong Kong, various issues.

Hong Kong figures should be closer to reality, and they indicate rapid growth of investment in Taiwan since 1999. Taiwanese investment in Hong Kong soared in the 1990s to support cross-straits activity. According to Taiwan’s statistics, Taiwan’s cumula-


tive outward approved FDI in Hong Kong amounted to US$1384 m. by the end of 2002, which was 2.3 per cent of Taiwan’s total outward FDI (Table 6.12). Most of the investment took place in the 1990s. Hong Kong was the fourth destination of Taiwanese investment after the Mainland, the USA and Singapore. In 2003, in anticipation of the Mainland–Hong Kong CEPA, Taiwan’s approved investment in Hong Kong quadrupled, and Hong Kong surpassed the USA to become the second largest destination of Taiwan’s outward investment after the Mainland.7 As a result of foreign exchange controls and Taiwan’s restrictions on investment in the Mainland, Taiwanese data on outward investment is highly distorted. Hong Kong figures on inward FDI from Taiwan should be more useful (Table 6.13). The 2002 stock of inward FDI from Taiwan was US$2346 m. at historical cost, and US$2628 m. at market value. Taiwan was the eighth largest investor in Hong Kong in 2002 in terms of the stock of inward FDI at market value. Taiwanese investment in Hong Kong has grown rapidly in recent years, and the 1997 reversion of Hong Kong does not seem to have had an adverse impact on Taiwan’s investment in Hong Kong.

Table 6.12 Taiwan’s approved direct investment in Hong Kong

1952–1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1952–2002 2003 1952–2003

Amount (US$ m.)

Taiwan’s total outward investment

Share of Taiwan’s outward FDI (%)

28 33 200 54 162 127 100 60 142 69 100 48 95 167 1384 641 2025

1 524 1 552 1 656 887 1 661 1 617 1 357 2 165 2 894 3 296 3 269 5 077 7 176 10 093 61 328 11 667 72 995

1.8 2.1 12.1 6.1 9.7 7.9 7.3 2.8 4.9 2.1 3.1 0.9 1.3 1.7 2.3 5.5 2.8

Source: Website of Investment Commission, Ministry of Economic Affairs, Taiwan (www.idic.gov.tw).

160 The Emergence of Greater China Table 6.13 Hong Kong’s inward FDI from Taiwan (US$ m.) Figures in brackets represent percentage shares of Hong Kong’s total inward FDI. Stock at Historical cost 1994 1995 1996 1997 1998 1999 2000 2001 2002

333 (0.51) 269 (0.38) 513 (0.82) 756 (0.81) 859* (0.84) 1026* (0.85) 1564* (1.03) 2077* (1.20) 2346* (1.34)

Market value

– – – 1205 (0.92) 2308 (0.88) 3423 (1.19) 3051 (1.07) 2628 (1.08)

* Estimated by adding flows on stock of 1997. Source: Census and Statistics Department, Hong Kong Government.

According to Taiwan’s figures, the sectoral composition of Taiwanese outward FDI in Hong Kong was dominated by services, reflecting Hong Kong’s position as a service hub. At the end of 2000, international trade has the largest share by value (38.1 per cent), followed by business services (19.7 per cent), finance and insurance (19.3 per cent), electronic and electrical appliances (7.7 per cent) and wholesale and retail trade (7.6 per cent).8

Conclusion As a result of Taiwan’s restrictions of Mainland-related trade and investment, the economic integration of Taiwan with the Mainland is shallow and asymmetric. While Taiwan’s Mainland-related commodity trade is

Trade and Investment Involving Taiwan 161 Table 6.14 Distribution of Taiwan’s outward FDI (percentages) Manufacturing

Services

91 34

8 64

Mainland’s cumulative contracted FDI (1979–2003)3

60

35

Hong Kong’s outward FDI in Mainland (2002 stock)4

22

69

Taiwan’s cumulative approved in Mainland1 in other regions2

Sources: 1. 2. 3. 4.

Table 6.3. Website of Taiwan’s Investment Commission (www.idic.gov.tw). Table 2.6. Table 5.2.

considerable, Mainland-related services trade (largely restricted to Taiwanese tourists visiting the Mainland) is relatively small. Moreover, Taiwan’s investments in the Mainland are largely limited to manufacturing, and Taiwan’s investments in services industries in the Mainland are very small. Table 6.11 shows that the share of services in Taiwan’s cumulative approved investment in the Mainland from 1991 to January 2004 was only 8 per cent, whereas the corresponding figure for Taiwan’s investment in other countries was 64 per cent. The share of services in Hong Kong’s 2002 stock of outward FDI in the Mainland was close to 70 per cent. The share of services in the Mainland’s cumulative contracted FDI from 1979 to 2003 was 35 per cent.9 Whatever the yardstick, Taiwan’s investment in services in the Mainland was by far too low. This is largely due to Taiwan’s restrictions. Despite Taiwan’s recent liberalizations, Taiwan–Mainland trade is still very unbalanced. In 2003, Taiwan’s exports to the Mainland were US$47.4 bn, which was 4.3 times the size of imports from the Mainland of US$11 bn. Flows of visitors were also highly unbalanced. In 2002, 3.66 million Taiwanese visited the Mainland, but less than 0.2 million Mainlanders visited Taiwan. A more balanced integration of the Mainland and Taiwan has to wait for the resolution of political differences between the two. While Taiwan’s electoral politics are complicated and difficult to predict, there are real political differences dividing the Mainland and Taiwan – differences that are not going to disappear soon. The tension over the Taiwan Strait since 1995 has set back Taiwan’s plan to develop Taipei and Kaohsiung as service hubs, and Taiwan’s service industries


continue to lag considerably behind those of Hong Kong. This has serious consequences for Taiwan’s future investments in the Mainland, as the liberalization of Mainland’s services scheduled from 2005 to 2007 according to Mainland’s WTO entry commitments is the focal point of China’s next wave of opening. Taiwan’s lack of investment in Mainland’s services and Taiwan’s lagging expertise in services industries will hamper future Taiwanese investment even should cross-Straits political tensions de-escalate. Taiwanese investment in the Mainland may continue to lag behind that of Hong Kong.

7 An Overall View of Trade and Investment in the China Circle

After discussing in detail the many estimates of bilateral trade and investment between members of the China Circle, it is useful to take the best estimates to construct an overview of the investment and trade among the trio. An accurate picture will correct for the erroneous impressions created by misleading statistics, and inform economic analysis and policy-making. Such a picture will also enable us to gauge properly the degree of integration of the trio in comparison with other regions such as the EU, the NAFTA and the ASEAN.

Investments of the China Circle The trio are very important in global flows of FDI. As mentioned before, the Mainland was the world’s number one host of FDI in 2002. Among developing economies, the Mainland has been the largest host of FDI every year since 1992. Hong Kong is a very big source and host of FDI as a result of the FDI intermediated through Hong Kong. Among developing economies, Hong Kong has long been the largest source and second largest host of FDI. The Mainland and Taiwan are also major investors among developing economies. According to UN figures, Taiwan and the Mainland have respectively the third and sixth largest stock of outward FDI among developing economies in 2002. Table 7.1 summarizes the FDI among the Chinese Mainland, Hong Kong and Taiwan in a matrix. The first row shows the investments of the Mainland in Hong Kong, Taiwan and the world. The second row shows the investments of Hong Kong in the Mainland, Taiwan and the world, while the third row shows the investments of Taiwan in the Mainland, Hong Kong and the world. The rows show the outward FDI of the respective economies by destination, while the columns show the 163

164 The Emergence of Greater China Table 7.1 Stock of FDI within the CEA (US$ m.), 2002 Figures in upper brackets indicate percentage share of the row total; those in lower brackets are column percentages.

From/In Mainland

Hong Kong

Taiwan

Mainland –

176 7952 (81.4) (39.6) 33 1114 (55.6) (7.4)

Hong Kong 49 1151 (80.0) (28.2) –

2 3465 (3.9) (1.3)

Taiwan

(0.0) (0.0) 1 9233 (0.9) (5.7) –

CEA

World

49 115 (80.0) (7.5) 178 718 (82.3) (27.3) 35 457 (59.6) (5.4)

61 394 (100.0) (0.9) 217 179 (100) (3.0) 59 553 (100) (0.8)

CEA total

209 906 (62.1) (47.0)

51 461 (15.2) (29.5)

1 923 (0.6) (5.7)

263 290 (77.9) (40.2)

338 126 (100) (4.7)

World

446 262 (6.3) (100)

174 474 (2.4) (100)

33 478 (0.5) (100)

654 214 (9.2) (100)

7 122 506* –

* World inward foreign direct investment. Sources: All data obtained from United Nations, World Investment Report 2003, New York 2003, except the following items: 1: Table 5.6; 2: Table 5.1; 3: Table 6.11; 4: Table 2.4; 5. Table 6.13.

inward FDI of the respective economies by source. For intra-CEA investments, the best estimates are used, as explained below in detail. Mainland’s stock of investment in Hong Kong In Table 7.1, the Mainland’s 2002 investment of US$49 bn in Hong Kong (row 1, column 2) is taken to be Hong Kong’s figure on its inward FDI from the Mainland (Table 5.6), rather than the Mainland’s figure on its outward FDI in Hong Kong. As mentioned in Chapter 5, Mainland statistics on outward FDI are highly inaccurate owing to the evasion of its foreign exchange controls. Mainland cumulative approved outward investment to the end of 2002 was only US$9.3 bn, and the cumulative investment in Hong Kong was only US$4 bn (44 per cent of the total).1 However, that was only 8 per cent of the 2002 stock of Hong Kong’s inward FDI from the Mainland of US$49 bn! The figure of the 2002 stock of Mainland outward FDI in the World Investment Report was US$35.5 bn

An Overall View of Trade and Investment in the China Circle 165

(United Nations 2003:303), which was still less than the Mainland’s inward FDI in Hong Kong alone. There is no good way to estimate the Mainland’s stock of outward FDI, owing to rampant evasion of foreign exchange controls in the Mainland in recent years. As the great bulk of the Mainland’s outward FDI is in Hong Kong, we may assume that 80 per cent of the Mainland’s FDI is in Hong Kong.2 Given this assumption, the Mainland’s stock of outward FDI in 2002 would be US$61.4 bn. The stock of inward FDI in Hong Kong from the Mainland is valued at historical cost instead of market price, as the data for the Mainland and Taiwan are reported at historical cost. Moreover, valuation at historical cost is more stable. The Mainland’s 2002 stock of FDI in Hong Kong is 80 per cent of Mainland outward FDI (by assumption), and 28 per cent of Hong Kong’s inward FDI. (The two percentages are shown in brackets beneath the figure of the stock of FDI.) Hong Kong has long been the foremost destination of the Mainland’s investment, and the Mainland has been the largest investor in Hong Kong since 1998. Hong Kong’s investment in the Mainland Hong Kong’s 2002 stock of investment of US$177 bn in the Mainland (Table 7.1, row 1, column 1) is taken to be Hong Kong’s figure on its stock of outward FDI in the Mainland and the British Virgin Islands (Table 5.1) instead of the Mainland’s figure of US$205 bn of cumulative inward FDI from Hong Kong from 1979 to 2002. As mentioned before, the Mainland’s figure of inward FDI from Hong Kong is biased upwards due to the ‘success indicator problem’ in reporting and the inclusion of non-Hong Kong capital channelled via Hong Kong. The Hong Kong figure of US$177 bn is 86 per cent of the Mainland figure. The Hong Kong figure includes Hong Kong’s outward FDI in the British Virgin Islands, which is channelled largely to the Mainland. Hong Kong’s 2002 stock of FDI in the Mainland is 81 per cent of Hong Kong’s outward FDI and nearly 40 per cent of Mainland’s inward FDI. Hong Kong’s stock of investment in Taiwan According to Taiwan’s figures, Taiwan’s cumulative inward FDI from Hong Kong from 1952 to 2003 should be $3808 m. (Table 6.10). This figure is on approval basis and should be larger than utilized investment. Moreover, cumulative flows over 51 years would include companies that have ceased operation. It is preferable to use Hong Kong’s figure for its 2002 stock of outward FDI in Taiwan of US$1923 m. (Table 6.11). This is 0.9 per cent of Hong Kong’s outward FDI and 5.7 per cent


of Taiwan’s inward FDI. While Taiwan is not a significant host of Hong Kong’s outward FDI, Hong Kong has been the third source of Taiwan’s inward FDI after the USA and Japan since the 1950s (excluding British Central America, which channels capital from elsewhere). Taiwan’s investment in the Mainland As Taiwan’s figure for its 2002 stock of outward FDI in the Mainland of US$26.6 bn (Table 6.1) is greatly understated because of Taiwan’s controls, it is preferable to use the Mainland’s figure on its stock of inward FDI from Taiwan of US$33.1 bn (Table 2.4). However, as mentioned previously, the Mainland’s figure is also likely to be biased downwards because a substantial amount of Taiwanese capital is channelled through Hong Kong, British Central America and other countries. Unfortunately, there is no good way to estimate the precise amounts involved. The Mainland’s figure is used for lack of a better option. In 2002, Taiwan’s stock of FDI in the Mainland was 55.6 per cent of Taiwan’s outward FDI, and 7.4 per cent of Mainland inward FDI. The Mainland was Taiwan’s foremost destination of investment, and Taiwan vied with the USA and Japan to be the second largest investor in the Mainland after Hong Kong. Taiwan’s investment in Hong Kong Taiwan’s figure of its 2002 stock of outward FDI in Hong Kong of US$1384 m. (Table 6.12) is biased downwards due to Taiwan’s foreign exchange controls. It is preferable to use Hong Kong’s figure of inward FDI from Taiwan of US$2346 m. (Table 6.13). The stock is again valued at historical cost instead of market price. It was 3.9 per cent of Taiwan’s outward FDI and 1.3 per cent of Hong Kong’s inward FDI. As mentioned before, Hong Kong was the fifth destination of Taiwanese investment (after the Mainland, British Central America, the USA and Singapore), and Taiwan was the eighth largest investor in Hong Kong. CEA and global investment The 2002 stock of total outward FDI of CEA was US$338 bn. (Table 7.1, row 3, column 5), which was 4.7 per cent of world FDI. Most of the outward FDI of the CEA was from Hong Kong. The 2002 stock of total inward FDI in the CEA (row 5, column 4) was US$654 bn, which was 9.2 per cent of world FDI. Most of the inward FDI of the CEA was in the Mainland. While CEA is a large player in global investment, CEA investment flows are dominated by investments within the CEA. Intra-CEA FDI (row 4, column 4) was US$263 bn, which was nearly 78 per cent of the


outward FDI of the CEA, or 40 per cent of the inward FDI of the CEA. This shows that the CEA has invested mainly within itself, and a very substantial portion of the FDI in the CEA came from the CEA. The figures are overstated by the amount of non-CEA investments intermediated via Hong Kong, but understated by the amount of Taiwanese investment channelled through non-CEA countries. On the whole, the figures should be fairly close to reality. There is no doubt that the CEA is highly integrated in terms of investment flows.

Trade of the CEA As mentioned before, the investment flows of Hong Kong and Taiwan in the Mainland have generated huge trade flows and the investments from Hong Kong and Taiwan have been the crux of the Mainland’s spectacular export drive. Table 7.2 shows the trade among the trio in matrix form. Official trade statistics are used to construct the table. Row 1 shows the Mainland’s

Table 7.2 Exports of the CEA (official statistics, US$ m.), 2003 The figures in the upper (lower) brackets indicate the percentage share of the row (column) total. From/To Mainland

Hong Kong

Mainland –

Hong Kong 76 289 (17.4) (33.5)

Taiwan

CEA total

World

9 005 (2.0) (7.3) 5 428 (2.4) (4.4)

85 294 (19.5) (11.3) 100 785 (45.0) (13.3) 49 781 (34.5) (6.6)

438 371 (100.0) (5.9) 223 762 (100.0) (3.0) 144 240 (100.0) (1.9)

95 357 (42.6) (23.6) 21 417 (14.9) (5.3)

28 364 (19.7) (12.5)

CEA total

116.774 (14.5) (28.9)

104 653 (13.0) (46.0)

14 433 (1.8) (11.7)

235 860 (29.3) (31.2)

806 373 (100.0) (10.8)

World

404 579 (5.4) (100.0)

227 721 (3.0) (100.0)

123 441 (1.7) (100.0)

755 731 (10.1) (100.0)

7 482 241

Taiwan

Source: China data: China Customs Statistics, Economic, Information and Agency, Hong Kong; Hong Kong data: Review of Overseas Trade, Census and Statistics Department, Hong Kong; Taiwan data: homepage of Board of Foreign Trade, Taiwan (www.trade.gov.tw).


exports to Hong Kong, Taiwan, the CEA and the world, column 1 exports to the Mainland from Hong Kong, Taiwan, the CEA and the world. The world’s exports to the Mainland are taken to be the Mainland’s imports from the world less the cost of insurance and freight, which create a differential between the value of exports f.o.b. and the value of imports c.i.f. Row 5 thus shows world exports to the respective economies, or, more simply, imports of the respective economies in f.o.b. prices.3

Complications of trade statistics The Mainland’s 2003 exports to Hong Kong (Table 7.2, row 1, column 2) were US$76.3 bn, which was 17 per cent of the Mainland’s exports, or 34 per cent of Hong Kong’s imports in f.o.b. prices. (The two percentages are shown in brackets beneath the figure of the Mainland’s exports to Hong Kong.) According to the Mainland’s official statistics, Hong Kong is the number two market for Mainland exports after the USA. However, as mentioned in Chapter 4, the Mainland’s statistics on exports to Hong Kong are biased upwards and the Mainland’s exports to other economies are biased downwards because a substantial portion of Mainland exports to Hong Kong are re-exported to third economies (including Taiwan). To get an accurate picture of trade among the CEA, adjustments for the Mainland’s trade via Hong Kong with third economies must be made. Internationally, exports are usually classified by region of consignment, while imports are classified by region of origin. This is because information on region of consignment is easily obtainable, and tariffs and quotas often depend on the region of origin. Theoretically, it is useful to classify exports by region of final destination, but this is difficult to implement as most economies cannot ascertain the final destination of their exports. As mentioned in Chapter 4, despite the reclassification by final destination in China customs statistics since 1993, the Mainland has not been able to trace accurately the ultimate destination of Hong Kong’s re-exports of Mainland goods to third economies simply because Hong Kong traders who have bought Chinese products are free to sell them to any country. The Mainland’s exports in Table 7.2 to Hong Kong and Taiwan are supposedly classified by region of final destination. In reality, they are classified neither by region of consignment nor by region of final destination. In terms of


final destination, the Mainland overstates its exports to Hong Kong, but understates its exports to Taiwan. In Table 7.2, the exports of Hong Kong and Taiwan are classified by region of consignment. In terms of final destination, Taiwan understates its exports to the Mainland but overstates its exports to Hong Kong because the bulk of Taiwan’s exports to Hong Kong are routed to the Mainland. It should be noted that, in the table, Hong Kong exports include re-exports, which are much larger than Hong Kong’s domestic exports.

Re-examination of trade in the CEA Given the detail discussion on Mainland–Hong Kong trade in Chapter 4 and Mainland–Taiwan trade in Chapter 6, two alternative matrices showing trade in the CEA are shown in Tables 7.3 and 7.4. Table 7.3 shows exports of the CEA by region of consignment; Table 7.4 shows domestic exports of the CEA by region of final destination. Table 7.3 Exports of the CEA by region of consignment (US$ m.), 2003 Figures in the upper (lower) brackets indicate the percentage share of the row (column) total. From/To Mainland

Hong Kong

Mainland

Hong Kong

–

96 1441 (21.9) (42.2) –

Taiwan 8 5402 (2.0) (6.9) 5 428 (2.4) (4.4) –

CEA total

World

104 684 (23.9) (13.9) 100 785 (45.0) (13.3) 49 781 (34.5) (6.6)

438 371 (100.0) (5.9) 223 762 (100.0) (3.0) 144 240 (100.0) (1.9)

95 357 (42.6) (23.6) 21 417 (14.9) (5.3)

28 364 (19.7) (12.5)

CEA total

116 774 (14.5) (28.9)

124 508 (15.4) (54.7)

13 968 (1.7) (11.3)

255 250 (31.7) (33.8)

806 373 (100.0) (10.8)

World

404 579 (5.4) (100.0)

227 721 (3.0) (100.0)

123 441 (1.7) (100.0)

755 741 (10.1) (100.0)

7 482 241

Taiwan

1. Hong Kong imports from China (Table 4.5) less 1 per cent (¥0.99) to allow for f.o.b./c.i.f. differential. 2. Mainland’s direct exports to Taiwan (Table 6.9). Other data are the same as Table 7.2.

170 The Emergence of Greater China Table 7.4 Domestic exports of the CEA by final destination (US$ m.), 2003 Figures in upper (lower) brackets indicate percentage share of the row (column) total. From/To Mainland

Mainland –

Hong Kong 2 5771 (0.6) (4.3) –

Taiwan 10 4332 (2.4) (8.5) 4693 (3.0) (0.4) –

CEA total

World

13 010 (3.0) (2.2) 5 189 (33.2) (0.9) 50 221 (34.8) (8.5)

438 371 (100.0) (5.9) 15 627 (100.0) (0.2) 144 240 (100.0) (1.9)

4 7203 (30.2) (1.2) 47 4324 (32.9) (11.7)

2 7895 (1.9) (4.7)

CEA Total

52 152 (8.7) (12.9)

5 366 (0.9) (9.0)

10 902 (1.8) (8.8)

68 420 (11.4) (11.6)

598 238 (100.0) (8.0)

World

404 579 (5.4) (100.0)

59 918 (0.8) (100.0)

123 441 (1.7) (100.0)

587 938 (7.9) (100.0)

7 482 241

Hong Kong

Taiwan

1. Hong Kong’s retained imports from the mainland (Table 4.5) less 1 per cent (¥0.99) to allow for the f.o.b./c.i.f. differential. 2. Mainland’s total exports to Taiwan (Table 6.9). 3. Review of Overseas Trade, Census and Statistics Department, Hong Kong. 4. Table 6.8. 5. Taiwan’s exports to Hong Kong retained for internal use (Table 6.5). Other data same as Table 7.2.

Table 7.3 shows that in 2003 the exports of the Mainland consigned to Hong Kong (including all of China’s exports via Hong Kong to third economies) were US$96.1 bn, which was 22 per cent of China’s exports and 42 per cent of Hong Kong’s imports (in f.o.b. prices). This is much larger than the US$76.3 bn in Table 7.2, which only includes part of the Mainland’s exports via Hong Kong as a result of the 1993 reclassification. Table 7.3 shows that in 2003 the exports of the Mainland consigned to Taiwan were US$8.5 bn (direct exports in Table 6.8), which was smaller than the US$9 bn in Table 7.2. This is because the figure in Table 7.2 included some exports to Taiwan consigned via Hong Kong. The second and third rows in Tables 7.2 and 7.3 are the same (the exports of Hong Kong and Taiwan). This is because Hong Kong and Taiwan report their exports by region of consignment. Hong Kong’s


2003 exports to the Mainland were US$95.4 bn, which was 43 per cent of Hong Kong’s exports and 24 per cent of the Mainland’s imports (in f.o.b. prices). The Mainland and Hong Kong were each the other’s foremost market and foremost supplier. This is due largely to the importance of Hong Kong’s entrepot trade. Taiwan’s 2003 exports to Hong Kong were US$28.4 bn, which was 20 per cent of Taiwan’s exports and 13 per cent of Hong Kong’s imports (in f.o.b. prices). In terms of region of consignment, Hong Kong was the second largest market for Taiwan after the USA. According to Taiwan’s statistics, the exports of Taiwan to the Mainland were only US$21.4 bn (declared direct exports in Table 6.6) because the bulk of Taiwan’s exports to the Mainland were consigned via Hong Kong. Table 7.3 shows that intra-CEA exports (column 4) of the Mainland, Hong Kong and Taiwan were respectively 24 per cent, 45 per cent and 35 per cent of their exports. Total intra-CEA exports (column 4, row 4) were US$55 bn, which was 32 per cent of CEA exports or 34 per cent of CEA imports (in f.o.b. prices). Trade in the CEA shows a substantial degree of integration. However, Table 7.3 exaggerates the integration of trade in the CEA for three reasons. First, the table is based on region of consignment instead of final destination, and the bulk of the Mainland’s exports consigned to Hong Kong were re-exported to non-CEA destinations. Second, part of Taiwan’s exports consigned to Hong Kong were also re-exported to non-CEA destinations. Third, the bulk of Hong Kong’s exports were reexports not made in Hong Kong and such goods should be excluded. Table 7.4 eliminates the above three biases as it reports domestic exports (excluding re-exports) by final destination. Row 2 of Table 7.4 shows the domestic exports of Hong Kong, excluding all re-exports. The columns of Table 7.4 show imports (in f.o.b. prices) by region of origin as re-exports are excluded. The total exports of the Mainland and Taiwan were the same as in Table 7.3, as the exports of the Mainland and Taiwan are mostly local products. However, the bulk of the exports of the Mainland and Taiwan to Hong Kong are re-exported elsewhere and such re-exports are accordingly deducted. Row 1 shows the Mainland’s exports. Mainland exports consumed in Hong Kong were only US$2.6 bn, which was 0.6 per cent of the Mainland’s exports and 4.3 per cent of Hong Kong’s retained imports (imports consumed in Hong Kong) in f.o.b. prices. Unlike the 1960s, Hong Kong was no longer an important final market for the Mainland. With rapid economic growth in Hong Kong, Hong Kong consumers


have shifted to high-quality consumer goods (automobiles, hi-fi audio equipment) produced by Japan. The Mainland’s 2003 exports to Taiwan were US$10.4 bn, which was 2.4 per cent of the Mainland’s exports, or 8.5 per cent of Taiwan’s imports (in f.o.b. prices). The Mainland’s exports to Taiwan were small partly because of Taiwan’s controls on imports of Mainland products. The CEA accounted only for 3 per cent of the Mainland’s exports by final destination. Row 2 of Table 7.4 shows that Hong Kong’s 2002 domestic exports to the Mainland were US$4.7 bn, which was 30 per cent of Hong Kong’s domestic exports or 1.2 per cent of the Mainland’s imports. The Mainland has vied with the USA to be the foremost market for Hong Kong products since 1993. Hong Kong was no longer an important supplier to the Mainland, owing to the decline of Hong Kong manufacturing. Hong Kong’s domestic exports to Taiwan were small. Row 3 of Table 7.4 shows that Taiwan’s 2003 exports to the Mainland were US$47.4 bn, which was 33 per cent of Taiwan’s exports and nearly 12 per cent of the Mainland’s imports (in f.o.b. prices). The Mainland surpassed the USA in 2002 to become the number one market for Taiwan, and Taiwan was the number two supplier to the Mainland after Japan. Taiwan and Hong Kong together supplied 13 per cent of the Mainland’s 2002 imports (in f.o.b. prices). Taiwan’s 2003 exports consumed in Hong Kong were US$2.8 bn, which was 1.9 per cent of Taiwan’s exports and 4.7 per cent of Hong Kong’s retained imports. Hong Kong was the eighth market for Taiwan. Taiwan was the third supplier of Hong Kong retained imports (in f.o.b. prices) after Japan and the USA. Intra-CEA 2003 exports were US$68.4 bn, which were only 11.4 per cent of the exports, and 11.6 per cent of the imports of the CEA. The degree of the integration of the CEA in term of trade flows is much lower than that in terms of FDI. This is because the investors of Hong Kong and Taiwan use the Mainland as a platform to manufacture labourintensive products for non-CEA markets, mostly the USA and the EU. The bulk of the Mainland’s 2003 exports (97 per cent) was for non-CEA markets. Hong Kong and Taiwan supply the Mainland with semi-manufactures, which are further processed in the Mainland for export to the USA and the EU. The Mainland is thus an important market for the duo, and the duo are an important supplier to the Mainland. The role of the duo as a supplier has declined somewhat in recent years with the Mainland’s import liberalization, which led to a shift in import composition away


from semi-manufactures to consumer durables. The Mainland remains the foremost market of the duo, as the Mainland market is large. Hong Kong had been an important supplier to the Mainland in the early 1990s, and Hong Kong’s domestic exports to the Mainland accounted for a record of 12 per cent of Mainland imports in 1990. However, with the decline of Hong Kong manufacturing, Hong Kong’s domestic exports to the Mainland declined rapidly in the 1990s, though Hong Kong still sources raw materials in third regions for re-export to the Mainland (Table 4.5). Taiwan is still the second largest supplier of the Mainland, though Taiwan’s share of Mainland imports declined from the record of 16 per cent in 1997 to 12 per cent in 2003. The combined share of the duo in the Mainland’s imports was over 20 per cent from 1991 to 1997, but declined to 13 per cent in 2003 with the Mainland’s import liberalization. The Mainland has surpassed the USA to be Taiwan’s foremost market since 2002, and the Mainland has vied with the USA to be the number one market for Hong Kong’s domestic exports since 1993. However, the Mainland is an export platform that processes semi-manufactures for export to the USA and the EU. If we net out the flow of semi-manufactures between the duo and the Mainland and look only at the flow of final products, the USA and the EU are still the foremost markets of the duo. The economic reality of the trio is that the USA is their largest market and Japan is their largest supplier of capital goods and technology. An inward-looking bloc of the trio excluding the USA and Japan would not be in the long-term interest of the trio. The Mainland will continue to liberalize its imports of consumer goods and will import more consumer goods relative to semi-manufactures. The Mainland will continue to shift its imports away from Taiwan and Hong Kong to Japan and the West. Taiwan and Hong Kong cannot remain important suppliers of the Mainland for long because their industrial bases are quite narrow. However, it is likely that the Mainland will remain an important market for Hong Kong and Taiwan owing to the sheer size of the Mainland economy. The Mainland has to look outside the CEA for its capital goods, technology and market. The liberalization of the Mainland’s imports will imply rich opportunities for East Asia and the world.

The degree of integration of the CEA in trade Table 7.5 gives the intra-regional export shares of the CEA from 1990 to 2003, with the shares of the EU, the NAFTA and the ASEAN presented

174 The Emergence of Greater China Table 7.5 Intra-regional export shares (percentages)

CEA by consignment by final destination EU NAFTA ASEAN

1990

1995

2000

2001

2002

2003

29.3 12.1 65.9 41.4 19.0

35.9 14.7 62.4 46.2 24.6

33.6 12.6 62.1 55.7 23.0

33.4 12.7 61.2 54.8 22.4

33.1 12.4 – – –

31.7 11.4

Sources: CEA data: see text; Other RTAs: World Trade Organization, World Trade Report 2003, World Trade Organization, Geneva, 2003:56.

for comparison. The intra-regional shares of the CEA are given by region of consignment and also by region of final destination. As expected, the former shares are much higher because of Hong Kong’s very significant entrepot role in handling trade within the trio and also between the trio and the rest of the world. The intra-regional export share of the CEA by region of consignment rose from 29 per cent in 1990 to a peak of 36 per cent in 1995, but declined to 32 per cent in 2003. The rise in the early 1990s was due largely to the increasing importance of Hong Kong as an entrepot, and the subsequent decline was due largely to the decline in the share of the Mainland’s trade via Hong Kong. The intra-regional export share of the CEA by region of final destination rose from 12 per cent in 1990 to nearly 15 per cent in 1995. This was due largely to the sharp rise in export of semi-manufactures from the duo to the Mainland in connection with investment in processed exports. However, the share declined to 11.4 per cent in 2003 owing largely to the falling share of the duo in the Mainland’s imports with import liberalization since the late 1990s. On the whole, the intraregional export shares of the CEA by region of final destination are low because the duo use the Mainland as an export platform for non-CEA markets. The intra-regional export shares of the EU and the NAFTA were much higher than those of the ASEAN and the CEA, largely because the former economies were very large. Even without preferential market access, a substantial share of the exports of the EU would naturally be within the EU, simply because the size of the EU economy relative to the world economy is quite large. The intra-regional export share, or, more generally, the intra-regional trade share, will vary with the size of the regional economy. The share


will rise when new countries are included in the region, or if a country involved experiences high GDP growth. A high share does not necessarily reflect a bias towards intra-regional trade. A better measure of intra-regional trade bias is the intra-regional trade concentration ratio, which is defined as the ratio of the intraregional trade share to that region’s share of world trade (World Trade Organization 2003:56). The measure adjusts for the size of the region and its openness to world trade. If the ratio is one, then the ratio of the intra-regional trade share is just the same as the region’s share of world trade. This means that trade is not particularly concentrated within the region. Otherwise, the concentration ratio should be higher than one. An increase in the concentration ratio means that trade is increasingly concentrated within the region. Table 7.6 shows the intra-regional trade concentration ratio of the CEA by region of consignment and region of final destination. The ratios of the EU, the NAFTA and the ASEAN are given for comparison. The concentration ratios of the CEA by region of consignment were high, again showing the importance of the role of Hong Kong as an entrepot. However, the concentration ratios of the CEA by region of final destination were low, which again shows that the duo are using the Mainland as an export platform for non-CEA exports. Both concentration ratios of the CEA have decreased rapidly. This is due to the decline in Hong Kong’s entrepot role and the Mainland’s import liberalization. In terms of trade by final destination, the concentration ratio of the CEA is lower than that of the EU and the NAFTA since 1995. This indicates that the CEA is very open and non-exclusive in terms of trade flows. As mentioned before, the Mainland’s import liberalization will benefit not only the duo but also the whole world. Table 7.6 Intra-regional trade concentration ratios

CEA by consignment by final destination EU NAFTA ASEAN

1990

1995

2000

2001

2002

2003

5.4 3.0 1.5 2.6 4.6

4.4 2.5 1.6 2.8 3.9

3.8 1.9 1.7 2.9 3.4

3.8 1.9 1.6 2.9 3.5

3.6 1.8 – – –

3.1 1.5 – – –

Source: CEA data: see text; other RTAs: World Trade Organization, World Trade Report 2003, World Trade Organization, Geneva, 2003:57.

176 The Emergence of Greater China Table 7.7 Concentration of FDI in the CEA (3) = (1)/(2). FDI refers to stock of the sum of inward and outward FDI.

(1) Intra-CEA FDI share (%) (2) CEA’s share of world FDI (%) (3) Intra-CEA FDI concentration ratio

1990

1995

2000

2001

2002

58.6 5.9 9.9

61.5 6.6 9.3

60.7 7.6 8.0

56.5 6.9 8.2

53.1 7.0 7.6

Source: See Table 7.1.

As in the case of trade, an intra-regional investment concentration ratio can be defined as the ratio of the intra-regional investment share to that region’s share of world investment. Table 7.7 shows the intraCEA FDI share and the intra-CEA investment ratio from 1994 to 2002. The data start from 1994 because that was the first year when data on inward FDI in Hong Kong were available. The intra-CEA FDI share (in terms of the inward plus outward stocks of FDI) rose slightly from 59 per cent in 1994 to 61 per cent in 1996, but gradually declined to 53 per cent in 2002. The initial rise was due to the rise of the share of the Mainland in Taiwan’s outward FDI. The subsequent decline was expected, as the share of the duo in Mainland inward FDI has declined consistently since 1992 (Table 2.5). The intra-CEA investment concentration ratio (in terms of the inward plus outward stocks of FDI) was 9.9 in 1994, which showed that the intra-CEA bias in investment was high. However, the ratio declined to 7.6 in 2002. The investment concentration ratio is much higher than the trade concentration ratio because the duo use the Mainland as an export platform for non-CEA markets. The ratio is biased upwards because of the non-CEA capital intermediated via Hong Kong. The CEA’s investment concentration had been extremely high in the early 1990s, but has since declined gradually for two reasons. First, in the early 1990s, the Mainland’s investment environment was not yet mature, and the duo had a great advantage owing to their kinship and cultural links. As the Mainland’s investment environment matures, other countries can also invest in the Mainland easily. Second, in the initial stage of the Mainland’s opening, investment in the Mainland was largely limited to export processing, which was the speciality of the duo. However, the Mainland gradually allowed investment in manufacturing geared towards the domestic market as well as investment in services.


Investments of the latter type tend to come from the USA, the EU or Japan as they are likely to be more technology-intensive and larger in scale. In terms of investment, the CEA is also getting more inclusive over time.

Exports of the China Circle in the international context The CEA is a large exporter. Table 7.8 shows the exports of the China Circle in the international context. In 2003, the Mainland, Hong Kong and Taiwan were respectively the world’s fourth, eleventh and fifteenth greatest exporters. The total exports of the China Circle were US$806 bn, which was first in the world. However, adding up the exports of the China Circle exaggerates its exports for two reasons. First, the bulk of Hong Kong’s exports consist

Table 7.8 Exports of the CEA: position among leading world exporters 2003 Exporter

Exports (US$ bn) (f.o.b.)

Position

Germany USA Japan Mainland France UK Netherlands Italy Canada Belgium–Luxembourg Hong Kong, China Korea Mexico Spain Taiwan Singapore Russia Sweden Malaysia Switzerland CEA (Gross) CEA goods*

748 724 472 438 385 304 293 290 272 255 224 194 165 152 151 144 135 101 101 101 806 530

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 (1) (3)

Note: * See text for method of estimation. Numbers in brackets are hypothetical rankings. Source: Homepage of World Trade Organization.


of re-exports that are not made in Hong Kong. To gauge the capacity of the Hong Kong economy to manufacture goods for exports, domestic exports rather than total exports should be the relevant measure. After deducting Hong Kong’s re-exports, the exports of the CEA should be US$598 bn. Second, we should deduct intra-CEA exports that amounted to US$68 bn. The adjusted 2003 exports of the CEA were US$530 bn, or third in the world, after the USA but ahead of Japan. It is clear that the CEA is a very large exporter.

Conclusion Our analysis shows that, in terms of commodity trade, the CEA is a very open region and is getting more open over time. While geographic and cultural proximity gives a slight tendency for trade to concentrate within the CEA, that tendency is not pronounced and is getting less pronounced over time. In terms of investment, the intra-CEA bias is quite substantial. However, the bias is exaggerated by the non-CEA investment intermediated via Hong Kong. Moreover, the tendency for investment to concentrate within the CEA is also getting less pronounced over time. The CEA is getting more open in terms of both commodity trade and investment. We do not have comprehensive data on services trade, as data on services trade by region are difficult to obtain. However, from Hong Kong data on services trade by region, we know Hong Kong and the Mainland are each the other’s foremost partner in services trade. In 2002, the Mainland accounted for 28 per cent of Hong Kong’s services trade, and Hong Kong accounted for 22 per cent of the Mainland’s services trade. However, Mainland–Taiwan services trade is small owing to Taiwan’s restrictions. While services trade is very large for Hong Kong, it is not large for either the Mainland or Taiwan. Hong Kong has an early foothold in the Mainland’s service sector as a result of the vast business network that grew from its pioneering investment in processed exports. As the Mainland is scheduled to open its service sector to the world from 2005 to 2007, the CEA will become more inclusive in terms of services trade. To sum up, the Mainland’s rapid economic development and opening will benefit not only the CEA but also the entire world.

8 Policy Issues

The integration of the trio has raised many policy issues. While this chapter discusses both Mainland–Hong Kong and Mainland–Taiwan policy issues, discussions of the latter issues are inevitably brief owing to the political deadlock after the election of Chen Shui-bian. As mentioned before, the economic performance of both Hong Kong and Taiwan have deteriorated greatly since the Asian financial crisis. Hong Kong has actively leveraged on its Mainland connections, leading to a sharp economic recovery since mid-2003. While economic difficulties have also spurred Taiwan towards closer economic links with the Mainland, the long-awaited breakthrough on direct transportation has yet to occur because of political animosity. As a result, Taiwan has not been able to utilize its Mainland connections to pull itself out of economic malaise. This chapter will discuss five policy issues in the integration of the trio: 1. The impact of the Mainland’s WTO entry. 2. The development of Mainland–Hong Kong policy coordination in various areas. 3. The impact of the Mainland–Hong Kong CEPA. 4. The further development of Taiwan–Mainland links. 5. The management of social and public health problems that arise in the duo from economic integration with the Mainland; for example, illegal migrant workers, and the transmission of SARS and other contagious diseases.

179


Impacts of the mainland’s entry into the WTO After 15 years of arduous negotiations, the November 2001 Ministerial Conference of the WTO held in Doha, Qatar, approved the accession of China, which was followed immediately by that of Taiwan. China became a member of the WTO towards the end of 2001, while Taiwan became a member at the beginning of 2002. As Nicholas Lardy (2002:104) has remarked: China’s WTO commitments, on market access and on rules-based issues, far surpass those made by founding members of the World Trade Organization and, in some cases, go beyond those made by countries that have joined the organization since its founding in 1995. While China’s commitments were very wide-ranging, they were scheduled to be implemented over six years ending in 2007. Most of the significant liberalizations in services would take place from 2005 to 2007. The more sensitive concessions in banking and renminbi business would not be implemented until the end of 2006. It is widely recognized that entry into the WTO poses adjustment problems for some of China’s major economic sectors, especially finance, banking, agriculture and heavy industries (steel, chemicals and automobiles) because they are heavily protected. As long as China can manage the transitional problems, the long-run benefits are large, as WTO entry will boost reform and opening in China. China is going through the most difficult phase of her reform process; namely, reform of state-owned enterprises (SOEs), banks and financial institutions. Entry into the WTO may well provide the decisive boost to China’s reform and opening, assuming China can manage the pains of transition. In the first two years of WTO accession from the end of 2001 to 2003, the Mainland managed the transition extremely well. In these two years, Mainland exports and imports grew very rapidly, by 65 and 70 per cent respectively. In 2003, the Mainland still had a large trade surplus of US$25.5 bn, though the share of the trade surplus to exports declined from 8.5 per cent in 2001 to 5.8 per cent in 2003. In anticipation of the Mainland’s WTO entry, FDI in the Mainland recovered from the doldrums of the Asian financial crisis after 2000. Utilized FDI set a new record of US$46.9 bn in 2001, and grew by another 12.5 per cent in 2002. In 2003, utilized investment grew by only 1.4 per cent as a result

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of SARS, but contracted FDI grew by 39 per cent, indicating that there would be rapid growth of utilized investment in 2004. Even the protected sectors were able to perform well. For instance, both foreign and local firms were able to increase sales in the rapidly expanding automobile market. The agricultural sector was also able to respond rigorously to opening. While imports of land-intensive crops such as grain increased, exports of labour-intensive commercial crops also grew rapidly. However, the threat to China’s banking may be more worrisome when foreign banks are able to conduct renminbi business with local individuals in 2006. Thus far, China’s reform of its debtridden state-owned banks has not been very successful. China has until 2006 to strengthen its banking system before the pressure of foreign competition. Neither Hong Kong nor Taiwan is heavily involved in the Mainland’s disadvantaged sectors; namely, agriculture and heavy industry. Hong Kong and Taiwan are heavily involved in the Mainland’s exportoriented light industries, which stand to benefit directly from WTO entry. Hong Kong, as the service hub of China, is also heavily involved in the Mainland’s services sector. WTO entry will speed up the opening of the Mainland’s services, providing tremendous opportunities for Hong Kong.

Impacts on exports Besides gaining NTR (normal trade relations) status from the USA, China also gained some protection against anti-dumping duties that are becoming more and more prevalent. The WTO has clear procedures on anti-dumping duties. A country that intends to levy anti-dumping duties has to notify the affected country beforehand and can impose such duties only after a process of consultation and investigation that establishes injury for the industry concerned. Before China’s WTO entry, some anti-dumping duties were levied on China even without prior notification; for example, Mexico in early 1993. The average duty was a massive 300 per cent, with the highest rate exceeding 1000 per cent! Mexico admitted that such a course of action would not have been taken were China a member of the WTO. The Mainland’s textile and clothing exports will expand because the ATC (Agreement on Textiles and Clothing) will be phased out in 2005. The greater part of Hong Kong’s remaining textile and clothing industries will relocate to the Mainland. While Hong Kong’s industrialists will gain, as Hong Kong has expertise in marketing and organizing


production in these industries, Hong Kong’s workers in these industries will lose their jobs. China’s entry to the WTO reinforced the spectacular expansion of Mainland exports and boosted the relocation of the labour-intensive industries of Hong Kong and Taiwan to the Mainland. Such industrial relocation accelerated the structural transformation of Hong Kong into the service hub of China. Impacts on industries selling to China’s domestic market While Hong Kong’s outward processing industries will benefit from the Mainland’s entry to WTO, the impact on Hong Kong’s manufacturing companies selling in the Mainland’s domestic market is uncertain. These companies will face a more open market, but there will also be more competition. While the manufacturing sector in Hong Kong is small, Hong Kong has a strong manufacturing network in Guangdong. Hong Kong is strong in some niche products such as micro motors for automobiles. The Mainland’s automobile industry is quite inefficient, and needs restructuring. To capitalize on the opportunity, Hong Kong has to upgrade the quality of its products and also forge strategic alliances with Chinese and foreign partners. The industrial base of Taiwan is much more diversified than that of Hong Kong. Taiwan will gain more than Hong Kong from the opening of the Mainland market, especially in electronics, computer parts, auto parts and chemicals. Thanks to Taiwanese investments, Dongguan– Shenzhen and Suzhou–Shanghai have emerged to compete with Beijing as the ‘silicon valley’ of the Mainland. Impacts on services trade China’s entry into the WTO will expand China’s trade. Given the efficiency of Hong Kong as a trading centre, the expansion of Mainland trade will imply a bigger cake for service providers. However, Hong Kong’s service providers will face keen competition from multinationals and also from the Mainland’s domestic firms. Despite stiff competition, Hong Kong has a strong comparative advantage in services, especially in the Mainland market. Services require people-to-people contacts. Geographic and cultural proximity are thus very important assets in services trade. Hong Kong residents do not need a visa to visit the Mainland. Hong Kong already has a head start in the services sector in the Mainland built upon its pioneering

Policy Issues 183

investments in outward processing. Hong Kong banks, including the Hong Kong and Shanghai Bank, the Bank of China Group with its 13 sister banks, and the Bank of East Asia, have long established branches in the Mainland. The Mainland’s offshore markets in stocks, bonds, loans and foreign exchange are active in Hong Kong. Besides financial services, Hong Kong should be able to find opportunities in telecommunications, IT, e-commerce, advertising and freight forwarding. Moreover, the CEPA has provided Hong Kong firms with preferential access to the Mainland’s market, as will be detailed later. As many multinational service providers are large, smaller Hong Kong businesses may not be able to compete on their own. However, with their knowledge and experience of the Mainland market, Hong Kong firms can form alliances with foreign partners (Hong Kong Trade Development Council 2001). The middleman role of Hong Kong The Hong Kong stock market has reacted very positively to China’s entry to the WTO. However, there are observers who worry that Hong Kong will lose its middleman role if the Mainland becomes more open because foreign businesses can deal directly with the Mainland. As mentioned before, though the gap in economic development between the Mainland and Hong Kong is narrowing, it is not likely that Hong Kong will rapidly lose its comparative advantage as a service hub. There are significant economies of scale and economies of agglomeration in trading and services activities, and it is very difficult for other cities to compete with Hong Kong because it is the established centre for the Mainland’s trade and investment. For the same reason, other cities have found it very difficult to challenge the leading positions of New York and London in world finance. Of course, Hong Kong has to maintain its lead in high-quality service skills. China is now well into the third decade of its reform era and many big multinationals have entered the China market and are dealing directly with China. Some of the prominent regional headquarters of multinationals in Hong Kong have moved the greater part of their operations to the Mainland. However, China’s entry into the WTO will attract a wave of small and medium-sized enterprises (SMEs) into the China market. Most SMEs will not be big enough to enter the Mainland market directly on their own, and they will seek help from Hong Kong firms and partners. In this age of electronics and the internet, the average firm size in developed countries is becoming smaller and SMEs are proliferating. Moreover, even though big multinationals are dealing


with the Mainland directly, they still source supporting services from Hong Kong. Impacts on Taiwan–Mainland links As mentioned in Chapter 3, WTO membership for the mainland and Taiwan does not imply automatic establishment shipping and air links, which will only be established after the diffusion of political tensions. However, Taiwan did liberalize its import and investment prohibitions against the Mainland in 2002 after WTO entry. The number of prohibited import items fell from 43.2 per cent of the total in November 2001 to 27.5 per cent in mid February 2002. Of the 108 items in Taiwan’s services sector that would be open to other economies, 58 items would be open to Mainland capital. Such liberalizations still fall short of WTO requirements. Taiwan’s decision in 2001 to liberalize its restrictions on large-scale investment in the Mainland (that is, the ‘no haste, be patient’ policy) was also implemented in 2002. Under the stimulation of Taiwan’s partial liberalizations and the Mainland’s rapid economic development, Taiwan’s Mainland-related trade and investment have grown rapidly since 2002. Taiwan’s exports to the Mainland dropped by 7.6 per cent in 2001, but grew by 40 per cent and 30 per cent respectively in 2002 and 2003. Taiwan’s imports from the Mainland likewise dropped by 5 per cent in 2001, but grew by 34 per cent and 38 per cent respectively in 2002 and 2003. Data on Taiwan’s investment in the Mainland are not very accurate, but all signs point to rapid growth in 2002 and 2003 (Table 6.1). Given the political tension between the Mainland and Taiwan, full liberalization of Taiwan–Mainland trade and investment will occur only after the political issues are resolved. If a political compromise is reached, the prospect of Taiwan–Mainland trade and investment is bright as the two economies are complementary as well as dynamic. Impact of direct Taiwan–Mainland links on Hong Kong The prohibition of direct air and shipping links is quite costly, as Taiwan is very close to the mainland and taking the route via Hong Kong is much more time-consuming, especially for business travellers. It should be noted that the official opening of direct trade between the two economies would affect Hong Kong’s transhipment as well as re-exports. Over half of the existing Taiwan–Mainland trade is already ‘direct’, that is taking the route of transhipment or cargo in transit instead of reexports via Hong Kong. At present, Taiwan–Mainland trade via Hong Kong amounts to around 1 million containers or 5 per cent of Hong

Policy Issues 185

Kong’s container throughput. In 2002, Guangdong accounted for over a third of Taiwan’s trade with the Mainland. Even with direct links, the bulk of Taiwan’s trade with Guangdong will still go through Hong Kong. With direct links, Hong Kong may lose around 3 per cent of its container throughput, which is not a great amount.1 The value of cross-Strait trade in 2002 was around US$42.7 bn, of which around US$31 bn went through Hong Kong. A third of this was Taiwan–Guangdong trade, the bulk of which would still go through Hong Kong with the establishment of direct links as Hong Kong is the natural hub of Guangdong. Direct links would imply a loss of trade for Hong Kong (in re-exports and also transhipment) of around US$20 bn. The rate of value added for such trade should be no more than 6 per cent (Sung 1998:123). This implies a loss in income of US$1.2 bn, or 0.74 per cent of Hong Kong’s 2002 GDP. The impact of direct air links on passenger traffic and tourism is likely to be significant. Taiwan has long been the second largest source of tourists for Hong Kong. In 2002, Taiwanese visitors to Hong Kong totalled 2.4 million (14.7 per cent of total tourist arrivals), of which around 1.1 million visited the Mainland via Hong Kong. After the establishment of direct links, if 70 per cent of these visitors were to bypass Hong Kong, Hong Kong’s tourist expenditure (excluding expenditure on international transportation) would fall by US$85 m. and its GDP by 0.04 per cent.2 The loss in passenger international transportation expenditure would be around US$236 m.,3 and Hong Kong’s GDP would fall by 0.12 per cent. Summing up, direct losses from trade, transhipment and tourism would only be around 0.9 per cent of Hong Kong’s GDP – that is, significant but not very large. Indirect losses that would occur are difficult to estimate, but could be large. In recent years, Jiangsu and Shanghai have replaced Guangdong as Taiwan’s foremost destination of investment. Direct links would divert more Taiwanese investment from the Pearl River Delta to the Yangzi Delta. This can have serious consequences for Hong Kong. Though indirect losses for Hong Kong can be large, indirect benefits can also be large. At present, exchanges across the Strait are very unbalanced because of Taiwan’s restrictions on imports, investments and tourists from the Mainland. With the opening of direct links, Hong Kong will be able to capture a substantial share of such business, as it is the premier hub of South China. Even in the very long run, an appreciable portion of Taiwan–Mainland trade and investment may still go through Hong Kong, partly because Hong Kong is the foremost service


hub of China, and partly because Guangdong will continue to be an important partner of Taiwan’s trade and investment. For instance, though South Korea and China established direct commercial links in 1991, a substantial portion of China-South Korean trade and investment continues to go through Hong Kong. It must be stressed that Mainland–Taiwan reconciliation is in the fundamental interest of the Asian region. Hong Kong would lose a significant amount of trade and tourists, but war in the Taiwan Strait would be a disaster for Hong Kong. Even a cold war would be very unsettling for investors. Reconciliation would mean peace and prosperity for the region. Though Hong Kong’s share of Mainland–Taiwan trade would diminish, the long-run gains could be greater as the pie would grow faster. The negotiation of direct air or sea links is often time-consuming in the best of circumstances. With political distrust on both sides, the negotiations will probably be protracted. The impact of the opening of direct links on Hong Kong will likely be gradual.

Development of Mainland–Hong Kong policy coordination As mentioned in Chapter 3, Hong Kong’s reversion to China has facilitated the process of integration, but progress was slow in the first five years of Hong Kong’s reversion largely because the elites in Hong Kong were concerned about the possible adverse impacts of deep integration on Hong Kong’s autonomy. Consensus on the necessity of deep integration was reached in Hong Kong only in 2002, and the pace of coordination accelerated in mid-2003 with the conclusion of the Mainland–Hong Kong CEPA. Initial phase of Mainland–Hong Kong policy coordination When Hong Kong reverted to China in 1997, ‘one country, two systems’ was an untried design. Beijing tried to interfere as little as possible, and Hong Kong had to take the initiative to shape its relations with the Mainland. Hong Kong’s economic crisis triggered by the AFC had prompted Hong Kong to leverage on its Mainland connections, but elites in Hong Kong were deeply divided on the desirability of deep integration. Moreover, politicians and government bureaucrats in Hong Kong had very little experience in handling relations with Beijing. It was not surprising that progress was initially slow. A Hong Kong/Guangdong Co-operation Joint Conference was established in March 1998, headed by Hong Kong’s chief secretary and

Policy Issues 187

Guangdong’s vice-governor. In September 1998, the Joint Conference reached agreements on environmental protection, on minor extensions of working hours of border checkpoints, and on measures to boost crossborder tourism. The Joint Conference was supposed to meet twice a year, but it met only thrice in the three years from March 1998 to mid-2001. This was a sign that the Hong Kong government had not been very active in pushing for coordination with Guangdong. The retirement of Anson Chan as Chief Secretary in 2000 removed an influential detractor of deep integration. Moreover, the Hong Kong economy continued to perform badly in the global economic slowdown of 2001, and the Hong Kong government wanted to speed up the coordination with Guangdong as a long-run strategy of economic development. In July 2001, the fourth meeting of the Joint Conference reached agreements on further cooperation on border checkpoints, environment and tourism. The two sides also agreed to cooperation on e-commerce, cooperative arrangements between the Hong Kong and Zhuhai airports, and the development of logistics and high-tech industries in Nansha, an economic and technological development district in the Pearl River Delta approved in 1993. In December 2001, right after China’s WTO membership was approved by the November 2001 Ministerial Conference of the WTO held in Doha, the Hong Kong government proposed to Beijing the conclusion of a free trade agreement between the Mainland and Hong Kong. Hong Kong businesses have long complained that Mainland–Hong Kong economic relations are unfair to Hong Kong because Hong Kong’s market is very open while the Mainland’s market is highly restricted. While negotiations were started in late 2001, progress was slow till late 2002 (Sung 2003). However, with the deepening economic crisis in Hong Kong, Beijing decided to act decisively to shore up the Hong Kong economy. Beijing’s policy became increasingly clear after the sixteenth party congress of the Communist Party of China held in the autumn of 2002, when Hu Jintao succeeded Jiang Zemin as party secretary. Tung Chee-hwa, chief executive of the HKSAR, announced that agreement on the CEPA would be reached in June 2003. Acceleration of Mainland–Hong Kong policy coordination After the signing of the CEPA in mid-2003, Beijing announced in rapid succession three other measures highly beneficial to the Hong Kong economy. First, Mainlanders would be allowed to visit Hong Kong individually, rather than in group tours as in the past. This gave a tremen-


dous boost to Hong Kong’s tourist industry. Second, the Mainland would allow banks in Hong Kong to conduct offshore renminbi business. Third, Beijing gave the green light to building the Hong Kong–Zhuhai–Macau bridge, which would reinforce the role of Hong Kong as the transportation hub of the Pearl River Delta (PRD). These measures, together with the favourable global economic environment, led to an abrupt turnaround in investor sentiment towards Hong Kong. Hong Kong’s heavy net capital outflows in 2002 and the first three quarters of 20034 turned into a net inflow in the fourth quarter of 2003, and the Hong Kong dollar has strengthened above its official rate since September 2003. Given the desire to push for deeper integration in Hong Kong and Beijing, the sixth meeting of the Hong Kong/Guangdong Cooperation Joint Conference on 6 August 2003 announced the intention to turn the PRD into one of the world’s economic super-zones. Under the blueprint, Hong Kong will continue to be a centre for logistics, shipping, trade, finance and high value-added services, while Guangdong will be a manufacturing hub. The Conference involved over a hundred officials from both sides, led by Hong Kong’s Chief Executive Tung Chee-hwa and Guangdong’s Governor Huang Huahua. The Conference agreed to expand cooperation in 12 areas, including infectious-disease notification, intellectual property rights and overseas promotion of the region. 15 taskforces were formed under the Conference to pursue matters of mutual interest (South China Morning Post, 6 August 2003:A1). Besides the taskforces established previously on environmental protection, tourism, cross-border infrastructure and border checkpoints, new taskforces were established on infectious-disease notification, intellectual property rights, implementation of CEPA, overseas promotion of the PRD and cooperation on education. A joint task force involving Hong Kong, Guangdong and Macau would start preparatory work on the bridge linking Hong Kong with Zhuhai and Macau. Summing up, besides CEPA, which is discussed separately below, effective policy coordination was achieved in seven areas: 1. 2. 3. 4. 5. 6. 7.

Regional infrastructure, Border area issues, Tourism, Technology policy, Integration of financial markets, Coordination to stabilize the exchange rate, and Coordination on China’s WTO entry.

Policy Issues 189

Besides the above issues, effective coordination has also been achieved in social and public health issues such as cross-border crime and fighting contagious diseases. However, economic issues will receive more attention. Many of the issues involve coordination with Guangdong.

Coordination in regional infrastructure It has been pointed out that there are too many seaports and airports in the Zhujiang Delta. Within just a couple of years after Deng’s 1992 southern tour, Beijing approved the construction of three deep-water ports adjacent to Hong Kong; namely, Yantian in Shenzhen, the Huizhou port in Daya Bay and Gaolan port in Zhuhai. This is in addition to the existing Guangzhou port and Shekou port in Shenzhen (Sung et al. 1995:193–8). As mentioned before, a successful international port must have sufficient freight to attract shipping companies to make frequent calls. A minimum freight volume of 1.5 million containers a year is needed for the efficient operation of a container port (Sung et al. 1995:196). Though the Hong Kong port is congested and there is the need for another port in the Zhujiang Delta, there will be inadequate freight to supply so many deep-water, ocean-going ports. As with port construction, there is also duplication in airport facilities. Within a region of 200 square kilometres in the Pearl River Delta there are four international airports (Hong Kong, Macau, Shenzhen and Guangzhou) and four local airports, including the large Zhuhai airport, which is designed to be an international airport (Sung et al. 1995:198). Each local government looks after its own interest and wants a seaport or an airport as a showpiece. The result is excess capacity and the duplication of facilities. Coordination and competition Though improvements in planning and coordination can avoid some duplication of facilities, a certain amount of excess capacity and duplication is essential for competition. Planners may be able to rule out the more obvious failure cases, but they may not have enough information to pinpoint the successful ones. A certain amount of trial and error is necessary and no amount of feasibility studies can replace the market test. The problem with ports and airports in the Pearl River Delta is not excess capacity per se, but the ability of local governments to subsidize ports and airports from the public purse. Public subsidy implies that there is no real market test, as a loss-making port or airport can continue to operate.


It has been pointed out that the participation of foreign capital in infrastructure development will imply more efficient resource use, as foreign investors will help government officials to evaluate the costeffectiveness of infrastructure projects (Sung et al.1995:202). Coordination of infrastructural development after 1997 The Sino–British dispute on the Patten proposals for constitutional reform in Hong Kong had hindered coordination of infrastructure development between Hong Kong and China. For instance, the construction of both Hong Kong’s new airport and container terminal number 9 had been held up for a while by the Sino–British dispute. The reversion of Hong Kong to China has led to better coordination of infrastructural developments in the Pearl River Delta. A Hong Kong–Mainland CrossBoundary Major Infrastructure Coordinating Committee was established in October 1997, taking over the agenda of the predecessor established in December 1994. However, it should not be assumed that Hong Kong’s reversion would solve the problem of coordination. For instance, neither Beijing nor the provincial government of Guangdong have been able to rationalize the many airports and seaports put forward by the local governments of the Pearl River Delta. Bureaucratic coordination may not be powerful enough to override local interests. Even if bureaucratic coordination is powerful enough, it is unlikely to be highly rational and efficient. Market coordination will give better results as long as the local governments refrain from giving undue subsidies to infrastructure. The participation of private capital and foreign investors in infrastructure should be encouraged as much as possible. Recently, China has allowed the increasing participation of foreign capital in infrastructure projects, including seaports. Hong Kong International Limited (HIT) has invested in the ports of Yantian, Shanghai, Gaolan and other feeder ports in the Zhujiang Delta (Cheng and Wong 1997:61). Swire Pacific and Peninsular & Oriental Stream Navigation Co (P&O) has acquired 50 per cent of the Shekou Container Terminal. The rapid growth of Yantian is largely due to the efforts of HIT. Unlike the case of seaports, it is more difficult to rationalize the many airports in the Pearl River Delta because private participation is much more restricted for airports. With the strengthening of the desire for deep integration in both Hong Kong and the Mainland, the Hong Kong Airport Authority is exploring ways to participate in the airports of the PRD. In 2001, Hong Kong’s airport began discussions on cooperation with those of Zhuhai and Shenzhen. Fast ferries have been established

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between the Hong Kong and Shenzhen airports. As the biggest player in the region, the Hong Kong airport is in the best position to initiate such cooperation. The July 2001 Hong Kong/Guangdong Cooperation Joint Conference gave the green light to the cooperation of the financially insolvent Zhuhai airport with Hong Kong. As Zhuhai has very few flights, cooperation has brought few immediate benefits, though it may pay off in the long run when the Hong Kong airport gets saturated with the expected rapid growth of traffic. Cooperation with the busy Shenzhen airport is more important. While the Hong Kong airport has many more international flights, the Shenzhen airport has more domestic connections and the synergy can be exploited to mutual advantage. However, Guangzhou had a new airport in operation in 2004 with an ambitious plan to become the hub in south China. Guangzhou also wants to strengthen its position by cooperation with Shenzhen. The rivalry between Hong Kong and Guangzhou may take time to resolve.

Coordination in border area issues Border area issues involve border checkpoints, environmental protection and the coordination of cross-border infrastructure, especially the construction of the Hong Kong–Zhuhai–Macau bridge. These issues involve coordination with Guangdong, though cross-border infrastructure involves the State Council (the Ministry of Transport and the Planning Commission) as well. Environmental protection To protect the environment, the two sides in the Hong Kong/ Guangdong Cooperation Joint Conference of September 1998 agreed to subject all large-scale public works in the border areas to environmental evaluation and mutual consultation. The two sides would undertake a joint study of air quality in the Pearl River Delta in 1999 as pollutants in the delta have led to a substantial deterioration in air quality in Hong Kong. In the fourth joint meeting of July 2001, the two sides agreed to study emission standards of vehicles, and also the possibility of releasing more data on the water quality of the Dongjiang, the major river supplying water to Hong Kong. Border checkpoints Congestion of border checkpoints has long been a source of complaint. Passenger crossings often take an hour or more, and large numbers of commuters suffer as a result. There have long been proposals to allow


24-hour operation of the major passenger checkpoints since Hong Kong’s reversion, but the agreement reached in late September 1998 after long negotiations was disappointing, as the opening hours of the four land crossings would be extended by only one to two hours. Even after the extension, no checkpoint would be open from 11.30 pm to 6.30 am. In the July 2001 meeting, the Hong Kong government agreed to extend the opening hours at Lowu, the largest checkpoint, by another 30 minutes during holidays. The feasibility of Joint immigration and customs facilities at the Western Border Crossing would be studied. The crossing, a bridge linking Hong Kong and Shenzhen, scheduled to be completed by the end of 2005, will double the possible rate of vehicular traffic between Shenzhen and Hong Kong. The Hong Kong government had reservations about 24-hour operation of passenger checkpoints as retail sales in Hong Kong have plummeted since the Asian financial crisis, partly because Hong Kong shoppers have swarmed to Shenzhen, where prices of goods and services are much lower. It was feared that greater ease of passenger crossing would have adverse impacts on retail sales and employment in Hong Kong, and might also depress real-estate prices in the northern New Territories. Vested interests in Shenzhen also have reservations about 24-hour crossing. As a result, a very small and easy step in integration has been delayed for a long time. With the strengthening of the desire for deep integration in both Hong Kong and Beijing, 24-hour operation of the passenger border checkpoint at the Lok Ma Chau–Huanggang crossing was eventually implemented on 27 January 2003, more than five years after Hong Kong’s reversion. Construction of the Hong Kong–Zhuhai–Macau bridge Besides the Western Crossing scheduled for completion in 2005, there are two big cross-border projects being planned. The Guangzhou–Hong Kong express railway will cut commuting time between Guangzhou and Hong Kong to less than an hour. However, it is only at the drawingboard stage. The Hong Kong–Zhuhai–Macau bridge has received more attention as its planning has entered the final stage. There have been numerous proposals to link Zhuhai and/or Macau with Hong Kong by a bridge since the 1980s. Hong Kong, which is on the eastern flank of the PRD, is separated from the cities on the western flank (Macau, Zhuhai and Zhongshan) by the Pearl River estuary. Transportation from Hong Kong to the western flank is quite inconvenient. Cities on the eastern flank (Shenzhen and Dongguan) have better com-

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munications with Hong Kong and they have developed much faster than the cities on the western flank in the reform era. The bridge would be around 30 kilometres long and would cut the driving time from Zhuhai to Hong Kong from around three hours to an hour. The bridge would bring substantial benefits to cities on the western flank of the PRD and would also be very important for the status of Hong Kong as the transportation hub of the PRD. While the bridge has long been supported by Zhuhai, Hong Kong was not enthusiastic up until mid-2002. With the worsening economic crisis in Hong Kong, the attitude of the Hong Kong government towards integration with the PRD then changed, and the Hong Kong government came out in support of the bridge. However, to make real procedure, the bridge has to receive the blessing of Beijing and Guangdong. Shenzhen, not surprisingly, wants a bridge linking Zhuhai with itself rather than with Hong Kong. The mainland’s transportation authorities also prefer this, as the bridge is an important link in the Mainland’s southeastern coastal highway. A bridge going to Hong Kong would not be able to serve such a link because Hong Kong is a separate customs territory with immigration and customs controls. There is thus a proposal to build a bridge with separate links to Hong Kong and Shenzhen on the eastern side, and also separate links to Macau and Zhuhai on the western. With the strengthening of the desire for deep integration on both sides, a breakthrough on the project was reached in the third meeting of the Hong Kong/Mainland Cross-Boundary Major Infrastructure Coordinating Committee in Shanghai in September 2002. The two sides agreed to start detailed studies of the bridge. Though planning and construction of the bridge may be time consuming, the two sides have agreed that the project should be given a high priority.

Coordination in tourism Hong Kong’s tourist industry has been severely hit by the Asian financial crisis because the Hong Kong dollar did not depreciate. At the end of May 1998, the government announced a package of seven measures to stimulate the sagging economy. One of the measures involved a 30 per cent increase in the quota allocated to Mainlanders joining the Group Tour Scheme to visit Hong Kong. (Such tours were started in the early 1980s and the quota was instituted to avoid illegal immigration.) Another measure was to simplify visa formalities for Taiwanese tourists who tour Hong Kong on their way to the mainland. These measures brought an upturn.


In January 2002, the quota system for the Hong Kong Group Tour Scheme was abolished. As a result, tourists from the Mainland rose by 53 per cent in 2002 to 6.8 million, accounting for 41 per cent of tourist arrivals in Hong Kong. Individual tours Starting late July 2003, Mainlanders in selected cities in Guangdong were allowed to visit Hong Kong on an individual basis, rather than joining group tours as in the past. The measure was extended to Beijing and Shanghai on 1 September 2003, and would be further extended to other regions of the Mainland. The World Tourism Organization projected that by 2020 the Mainland will generate 100 million outbound tourists a year. Moreover, it will attract 130 million international arrivals a year and will surpass France to become the world’s leading tourist destination (South China Morning Post, 21 October 2003:B1). As Hong Kong is China’s foremost hub of air traffic, a substantial portion of these tourists may pass through Hong Kong and tour Hong Kong on their way to the final destination. The Mainland can generate almost an unlimited number of tourists for Hong Kong. In the light of this projection, the report that individual tours would bring another 4 million tourists a year for Hong Kong (Sing Tao Daily, 20 August 2003:A6) appears to be quite modest. It is estimated that individual tourists would generate income of $13.7 billion or 1.1 per cent of the 2002 GDP if they spend the same amount as the average Mainland tourist (Sung 2004). However, the expenditures of tourists on individual tours may be quite different from those on group tours. One survey indicates that they spend an average of $8652 per person trip, much more than the average expenditure of the Mainland tourist of $5000 in 2002 (Ming Pao, 24 November 2003:A10). They are more likely to buy insurance and open securities and bank accounts in Hong Kong. They also spend less on hotels and more on shopping. Without a good survey, it is not possible to be more precise. On 1 September 2003, the Mainland raised the limit on the amount of foreign currencies that Mainland residents travelling abroad are allowed to carry from US$2000 to US$5000. This eases the pressure on the renminbi to appreciate, and also gives a further boost to the Hong Kong economy. It is important to stress that the contribution of individual tours goes far beyond tourism. Individual tours lower the transaction cost of business between Hong Kong and the Mainland. It is more convenient for Mainlanders to conduct businesses in Hong Kong; for example, to open security accounts for the trading of securities, to

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search for investment property or to undergo medical operations and so on. Like the CEPA, individual tours improve access for Hong Kong’s services industries to the Mainland market. Moreover, individual tours facilitate and hasten opening and economic reforms in the Mainland. As services are performed on people, there are two alternative ways to export Hong Kong services to the Mainland. One is to allow Mainlanders to come to Hong Kong, the other to allow Hong Kong’s services firms to set up outlets in the Mainland. The two ways interact and reinforce each other. For instance, individual tours facilitate the trading of H shares in Hong Kong by Mainlanders.5 This may hasten the relaxation of the Mainland’s restrictions on outward investment. Moreover, individual tours imply more tourists bringing more renminbi to Hong Kong. This hastens the liberalization of renminbi business for Hong Kong banks. Hong Kong Disneyland, scheduled to open in 2005, is projected to attract 3.4 million overseas tourists. By 2020, the park will reach full capacity, attracting 7.5 million overseas tourists. The bulk of the overseas tourists will be from the Mainland and this will necessitate further coordination between Hong Kong and China.

Coordination in technology policy Hong Kong, despite its lagging technical capacity in comparison with Singapore, Taiwan and South Korea, is uniquely positioned to utilize the research and engineering capability of the Mainland. Moreover, in comparison with its rivals, Hong Kong has the advantage of close links with the Mainland’s vast internal market. The government announced new measures to promote technology in October 1998, including the establishment of an applied science and technology research institute. The importation of skilled professionals from the Mainland without quota started in early 2000. Upgrading Hong Kong’s technology is perceived to be in the interest of Guangdong and the Mainland, as the labour-intensive processing industries in Guangdong need upgrading. In July 1999, China’s State Council designated Shenzhen a pilot hi-tech development area to promote hi-tech jointly with Hong Kong. Beijing has already approved the setting up of around 50 hi-tech institutions in Shenzhen, where they can cooperate with Hong Kong businesses. The July 2001 Hong Kong/Guangdong Joint Conference agreed jointly to develop logistics and hi-tech industries in Nansha at the heart of the Pearl River Delta. Nansha was approved as an economic and technological development district in 1993.


Integration of financial markets As mentioned before, H-shares and Red Chips account for more than a quarter of the capitalization of the Hong Kong stock market. The Mainland’s rapid development would imply a huge demand for foreign funds. As more Mainland enterprises seek listing in Hong Kong, Hong Kong could become one of the world’s largest stock markets. While Hong Kong’s comparative advantage in funding the Mainland’s development could help Hong Kong develop into a truly first-rate international financial centre, managing the Hong Kong currency will be increasingly difficult as it is used for the transaction of the shares of Mainland enterprises listed in Hong Kong. The volume of such transactions will be exceedingly large and the Hong Kong currency would be vulnerable to speculative attack. In the long run, it is better to trade such stocks in US dollars to insulate the local economy from the flow of funds involved in offshore financial activities (Liu 1998:23–4). The Hong Kong Monetary Authority has secured the help of HSBC, a private bank, to assume the risk of clearing US dollars in Hong Kong. An RTGS (real time gross settlement) clearing system in US dollars was established in the third quarter of 2000. This would promote US-dollarbased financial transactions in Hong Kong and also enhance Hong Kong’s status as an international financial centre. At present, the bulk of syndicated loans and bonds in the Hong Kong market are denominated in foreign currencies (mostly US dollars). However, stocks are quoted and traded in Hong Kong dollars, though more and more of them are likely to be quoted and traded in both US and HK dollars in the future. A Growth Enterprise Market Board was established in Hong Kong in November 1999 to facilitate new companies to raise capital. Many new technology companies raise capital through the Board, including technology companies in China. From 1993 to 2002, Mainland enterprises raised a total of US$18 257 m. in the Hong Kong stock market (Prasad 2004:53). Fostering offshore renminbi business In mid-November 2003, the People’s Bank of China and the Hong Kong Monetary Authority signed a Memorandum of Cooperation on the operation of renminbi (RMB) business in Hong Kong. Banks in Hong Kong are allowed to conduct RMB business in a limited way starting in 2004. The scope of business is limited to personal accounts and four areas; namely, deposits, remittances, currency exchange and credit cards.

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RMB deposit accounts are restricted to Hong Kong residents, but not for businesses. Holders of RMB deposit accounts are permitted to convert RMB into Hong Kong dollars and vice versa, up to a limit of RMB20 000 per day. RMB account holders are permitted to remit RMB from their Hong Kong accounts to accounts under the same name in the Mainland subject to a limit of RMB50 000 per person per day. Mainlanders are permitted to use Mainland-issued RMB debit and credit cards in Hong Kong, with no ceiling on spending (HSBC Monthly Report: 10, December 2003). While the volume of business involved is relatively small because deposit accounts are restricted to individuals with daily limits, the longterm implications for the Mainland and Hong Kong are significant. First, the measures signify the commencement of partial convertibility for offshore RMB, and the volume of business will grow with progressive relaxations of restrictions. Mainland authorities can gain experience through current measures for further capital account liberalization. Second, the measures give Hong Kong a first-mover advantage in offshore RMB business, and the RMB has the potential to become a major international currency. The measures, together with the CEPA, strengthen Hong Kong’s status as an international financial centre. Third, the measures facilitate other Mainland–Hong Kong economic links; for example, tourism, cross-border business deals and trade in services. Besides fostering offshore RMB business in Hong Kong, since 2003 Mainland authorities have discussed relaxing the Mainland’s restrictions on outward investment through a QDII (qualifed domestic institutional investor) scheme; for example, allowing domestic mutual funds to invest overseas. In February 2004, China’s State Council decided in principle to allow the Mainland’s Social Security Fund to invest overseas, though the details have yet to be worked out (Sing Tao Daily, 21 February 2004: B3).

Coordination to stabilize the exchange rate Unlike other East Asian economies, the Mainland and Hong Kong have maintained their exchange rates against the US dollar during the AFC. Both governments have reiterated their determination to keep their exchange rates stable. Coordination in exchange rate policies between the Mainland and Hong Kong have contributed to financial stability in East Asia (Sung 1998:165–7). President Clinton acknowledged the importance of the economic roles of the Mainland and Hong Kong in the Asian financial crisis in his visit to the Mainland and Hong Kong in late June and early July 1998.


As Hong Kong has a small economy in which the volume of international transactions is relatively large, it should peg its exchange rate to an international currency. This would facilitate international transactions. At present, Hong Kong cannot peg its currency to the RMB because it is not convertible. Even when the RMB becomes convertible, it may be advantageous for Hong Kong to continue its peg to the US dollar as this would distinguish Hong Kong from other financial centres in the Mainland. However, by the time the RMB becomes a major international currency it may be preferable for Hong Kong to switch its peg to the RMB. Though the renminbi and the Hong Kong dollar are at present two separate currencies, their exchange rates are interdependent because the two economies are closely tied to each other in many ways. For example, a revaluation of the RMB would make Hong Kong more competitive. Moreover, because of China’s foreign exchange controls, international investors often take advantage of opportunities in the China market by investing in Red Chips and H-shares in the Hong Kong market. An expected revaluation of RMB would lead to capital inflow into Hong Kong. The Mainland recovered from the AFC very rapidly and its foreign exchange reserves swelled with persistent surpluses in both the current and capital accounts. In early 2003, the USA led a new round of international calls on China to revalue its currency as the US bilateral deficit with China continued to soar. China did not revalue, but liberalized the restrictions on imports and outgoing tourism, especially allowing Mainlanders to visit Hong Kong individually. The prospect of the revaluation of the renminbi and the weakness of the US dollar led to large capital inflows into Hong Kong in September 2003, and the exchange rate of the Hong Kong dollar strengthened above the official rate. The Hong Kong Monetary Authority reiterated its long-standing policy of maintaining a fixed exchange rate against the US dollar, and effectively contained the rise of the Hong Kong dollar through intervention in the foreign exchange market. In early 2004, China’s imports rose sharply due to import liberalization, and China’s persistent trade surplus turned into a deficit in the first two months of 2004. As a result, speculative pressure on both the RMB and the Hong Kong dollar eased. Unlike Hong Kong, the Mainland’s long-run interest is best served by a flexible rather than a fixed exchange rate because the Mainland economy is large. While many small economies have pegged their currencies to those of their major economic partners, most large economies

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allow their exchange rates to float. For large economies, the burden of a fixed exchange rate system usually outweighs the gains. However, China has to reform its financial system before it can adopt a floating exchange rate system. In particular, China has to reform its insolvent state-owned banks before it can open its capital account. With success in financial and banking reforms, China will be able to allow more flexibility in its exchange rate.

Coordination on the Mainland’s WTO entry Hong Kong had long supported the Mainland’s entry into the WTO. Hong Kong government officials and politicians had also lobbied the US government and the US Congress to grant NTR status to China in early 2000. In October 1999, the Hong Kong government set up an interdepartmental group chaired by the financial secretary to liase with Mainland authorities on matters related to China’s WTO entry. Its purpose was to become acquainted with the arrangements for the opening up of the Mainland market, and to enable Hong Kong businesses to capitalize on the emerging opportunities. Additionally, the Mainland’s Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and Hong Kong’s Trade and Industry Bureau set up a joint committee in November 1999 to strengthen communication on economic and trade issues. Coordination on such issues was later subsumed under the Mainland–Hong Kong CEPA.

The Mainland and Hong Kong CEPA The Mainland and Hong Kong CEPA was signed on 29 June 2003 and took effect on 1 January 2004. It covers three broad areas; namely, trade in goods, trade in services and trade and investment facilitation. The CEPA grants zero tariffs to Hong Kong manufactures in 273 product categories. It gives preferential access to Hong Kong companies in a wide range of service industries above and beyond the Mainland’s WTO commitments. It also provides opportunities for Hong Kong professionals and residents to establish business or work on the Mainland. The Mainland and Hong Kong CEPA is unprecedented in many ways. As mentioned before, it is the first FTA formed between two separate customs territories within the same nation. Another peculiarity of the CEPA is that it involves two economies that are quite asymmetric in size, in openness and in level of development. The Hong Kong economy


is small, highly developed and very open, while the Mainland is large, less developed and relatively closed. The benefits of the CEPA for Hong Kong are obvious, as it involves the preferential opening of the vast Mainland market to Hong Kong. There are few gains for the Mainland in terms of market access as the Hong Kong market is small and already very open. However, as Hong Kong is by far the foremost investor in the Mainland, the Mainland is likely to gain from an increase in investment from Hong Kong through investment and trade facilitation. Moreover, by opening its highly protected services sector selectively to Hong Kong ahead of WTO commitments, the Mainland would help its service industries to adapt and adjust to face the rigours of world competition. Lastly, the Mainland–Hong Kong CEPA of course symbolizes the union of Hong Kong to its motherland. The arrangement has considerable attraction for Taiwan. Trade in goods The Mainland agreed to apply a zero import tariff for Hong Kong manufactures in 273 Mainland product categories, starting 1 January 2004. This went beyond China’s WTO commitments, which will cut the average tariffs for industrial products to 8.9 per cent by 2005. The product categories cover the main manufacturing industries of Hong Kong; namely, electrical and electronic products, textiles and clothing, plastic articles, watches and clocks, jewellery and metal products. Tariff exemption will be extended to other product categories upon application by local manufacturers no later than 1 January 2006. As production costs are high in Hong Kong and Hong Kong manufacturing has declined for two decades, the CEPA is not expected to bring a massive revival of Hong Kong manufacturing. However, Hong Kong has better protection of intellectual property rights than the Mainland and the CEPA will benefit high-value-added manufacturing, especially industries in which intellectual property rights protection is crucial. It will help Hong Kong to develop brand products targeting the Mainland’s middle-class consumer market. Trade in services The CEPA gives preferential market access to 18 service sectors; namely, three sectors under financial services (banking, securities and insurance), four sectors under transportation (logistics, freight forwarding, storage and warehousing, and transport services), one sector under trade-related services (distribution), one sector under travel services (tourism), five sectors under professional and business services (management consult-

Policy Issues 201

ing, advertising, accounting, legal, and medical and dental services), and four sectors of other services (telecommunication, construction and real estate, exhibition and convention, and audio-visual services).6 The preferential access takes one of more of the following forms: 1. Lower market access requirements – The high-entry thresholds set under China’s WTO commitments are reduced for Hong Kong firms. For instance, the asset requirement of banks is reduced from US$20 bn to US$6 bn; the annual sales and asset value of retailers are lowered from US$2 bn and US$200 m. respectively to US$100 m. and US$10 m.; the trading and capital requirements of import and export trade are also lowered. As service providers in Hong Kong tend to be small, the lowering of market access requirements allows many more Hong Kong companies to enter the Mainland market. 2. Broader business scope – The geographic restrictions set under China’s WTO commitments are relaxed for Hong Kong firms under the CEPA. For instance, in retail trade, only major cities (mostly provincial capitals) are open to foreign companies in 2004, while the CEPA permits Hong Kong companies to operate in all cities at the prefectural level, and all cities at the county level in Guangdong province. In tourism, the geographical restrictions on foreign companies are lifted for Hong Kong companies. 3. More corporate autonomy – Hong Kong companies can establish wholly-owned ventures while other foreign companies are restricted to joint ventures in convention and exhibition and in real-estate services (architecture, engineering, surveying). 4. Earlier market entry – Hong Kong companies can establish whollyowned ventures (as opposed to joint ventures) ahead of other foreign companies in logistics, freight forwarding, transport services, management consulting, tourism and advertising. (Hong Kong Trade Development Council 2003:ii) There are many other significant concessions that cannot be captured by the above categorization. For example, imported films are restricted to 20 foreign films per year on a revenue-sharing basis, but Hong Kongproduced Chinese-language films are free from the import quota. The requirements for the co-production of films have also been relaxed significantly for Hong Kong. Besides Hong Kong companies, Hong Kong professionals and residents will also benefit from the CEPA. For instance, Hong Kong professionals in the securities and insurance industries can apply to practise on the Mainland and Hong Kong permanent residents are permitted to


sit Mainland’s legal qualifying examination (Hong Kong Trade Development Council 2003:iv). The CEPA has several provisions that aim to strengthen Hong Kong’s cooperation with Guangdong. For instance, Hong Kong lawyers’ residence requirements for operating in Guangzhou and Shenzhen are waived. Qualified Hong Kong retailers are allowed to set up operations in all cities at the county level in Guangdong, while Hong Kong residents are allowed to set up individually owned retail stores in Guangdong. Impact of the CEPA on the Hong Kong economy As mentioned before, the Mainland’s service sectors will develop faster with liberalization after WTO entry, and Hong Kong’s status as the premier service hub of China will face more competitive pressure. In the production chain of processed exports, the Mainland will increasingly source producer services locally rather than from Hong Kong, and Hong Kong’s rate of re-export margin may decline further. However, WTO entry and economic development will open up new markets for high-end services in which Hong Kong has a comparative advantage; for example, financial services. Hong Kong will lose out in low-end entrepot services, especially trade-supporting services that are directly related to the physical movement of cargo (for example, shipping, trucking and warehousing), and Hong Kong has to look for opportunities in high-end niches such as logistics, financing, insurance, arbitration, company headquarter functions, and high-quality personal services. In other words, Hong Kong has to face the challenge of rapid structural change in its service sector, and can succeed only if it maintains its lead in skills and service quality. The CEPA helps Hong Kong to rise to the challenge of structural change in services, as it gives preferential access for Hong Kong firms to the Mainland’s services sector. The rapid conclusion of the CEPA signifies that China’s new leadership gives a high priority to Hong Kong, and this is one of the main factors that reversed investor sentiment towards Hong Kong in late 2003. The CEPA also strengthens Hong Kong’s role as an international financial centre, trading centre and services hub. For instance, the ‘Financial Services Cooperation’ provisions in the CEPA encourage the Mainland banks to relocate their international treasury and foreign exchange trading centres to Hong Kong and to develop networks in Hong Kong through acquisition (Hong Kong Trade Development Council 2003:29). The CEPA also includes a clause that encourages more Mainland companies to seek listing in Hong

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Kong. The CEPA will strengthen the Hong Kong–PRD nexus, enabling the industrial powerhouse of the PRD to utilize the sophisticated supporting services of Hong Kong in logistics, distribution, financial services and business services. In a nutshell, the CEPA will strengthen Hong Kong’s position as the premier service hub of China. The CEPA will attract more foreign investment into Hong Kong, and it will also increase Hong Kong’s Mainland-related exports. The CEPA will attract foreign investment in Hong Kong in both manufacturing and services. For manufacturing, the CEPA rules of origin are quite liberal, following mostly existing rules of origin used in Hong Kong. For products in which a value-added criterion is used, no more than 30 per cent of the value added is required to be generated in Hong Kong. For services, the definition of a Hong Kong service company is quite liberal. The company must be registered in Hong Kong and have operated substantively in Hong Kong for the past three to five years. It must be liable to pay Hong Kong profit tax and must employ at least 50 per cent of its staff locally. Foreign investors can easily acquire control of local companies to fulfil the above definition. It is difficult to estimate the amount of investment that the CEPA will attract because the CEPA was only implemented in 2004. However, Taiwan’s approved FDI in Hong Kong had already quadrupled in 2003 in anticipation of the CEPA, and Hong Kong surpassed the USA to become Taiwan’s second destination of outward FDI after the Mainland. Ultimately, the amount of investment attracted will be dependent on the export opportunities that the CEPA can generate. The effects of the CEPA on Hong Kong are very wide-ranging and difficult to quantify. However, it is easier to assess the impact of the CEPA on Hong Kong’s Mainland-related exports, as Sung (2004) has conducted a detail study on the income generated by Hong Kong’s Mainland-related exports (decomposed by exports of goods and different kinds of services exports), and the study gives a convenient framework to gauge such impacts. As mentioned before, Hong Kong’s Mainland-related exports were huge, generating 32 per cent of Hong Kong’s GDP in 2002. For reasons that will be explained below, it is unlikely that the CEPA will have considerable effects on Hong Kong’s Mainland-related exports in the short run, but the long-run effects can be extensive. CEPA gives tariff exemption for Hong Kong’s domestic exports to the Mainland, but the income generated by such exports in Hong Kong’s GDP declined rapidly from 3.1 per cent in 1995 to only 1.8 per cent in 2002 (Sung 2004). Moreover, more than two-thirds of Hong Kong’s domestic exports to the Mainland involve components and inputs used


in outward processing (Table 4.6), which are tariff-exempt. The CEPA would thus only benefit around a third of Hong Kong’s domestic exports to the Mainland. Given the high production costs in Hong Kong, the impact of the CEPA on Hong Kong’s domestic exports will not be great in the short run. The Federation of Hong Kong industries estimated that the CEPA will create 5000 new jobs in manufacturing in 2004 (Hong Kong Economic Times, 17 March 2004: A5), which is only 2.6 per cent of Hong Kong’s 2002 manufacturing employment, and only 0.15 per cent of Hong Kong’s 2002 total employment. In the long run, however, it is certainly possible that Hong Kong may be able to capture some significant niches of the Mainland’s vast and expanding consumer market. The Federation of Hong Kong Industries surveyed its members in mid2003 and concluded that the CEPA will create 20 to 30 thousand new jobs in Hong Kong manufacturing in the coming three years (Hong Kong Economic Times, 27 June 2003: A6). In the long run, if Hong Kong entrepreneurs can exploit the market opportunities of the CEPA to the full, the CEPA may be able to stabilize or even reverse the decline of Hong Kong manufacturing. The CEPA will stimulate exports in the 18 services sectors mentioned, but the short-run effects will be small except for tourism. The income generated by Mainland-related exports in the three sectors in financial services (banking, securities and insurance) and in the nine sectors in professional and business services and other services were only 0.1 per cent and 0.5 per cent of Hong Kong’s 2002 GDP respectively. The income generated was small because such service exports were small. The income generated by Mainland-related exports in the four sectors in transportation services (logistics, freight forwarding, storage and warehousing, and transport services) was more significant, but still only 1.4 per cent of Hong Kong’s 2002 GDP. The increase in transportation services in the short run cannot be very large. The income generated by Hong Kong’s exports of Mainland-related tourism was 1.9 per cent of Hong Kong’s GDP, which was not insignificant. As mentioned before, 6.8 m. Mainlanders visited Hong Kong in 2002, accounting for 41 per cent of Hong Kong’s tourist arrivals. It was estimated that individual tours would bring another 4 m. Mainland tourists (Sing Tao Daily, 20 August 2003: A6). This would generate income of US$1.8 bn or 1.1 per cent of Hong Kong’s 2002 GDP, which is not insignificant. The big items in Hong Kong’s exports of Mainland-related services were related to trade: entrepot services and services involving offshore trade. The two items generated respectively 20.5 per cent and 2.6 per

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cent of Hong Kong’s 2002 GDP. The CEPA should stimulate services involving offshore trade, as Hong Kong traders and forwarders have better access to the Mainland market under the CEPA. However, it would have very little impact on entrepot trade, which is suffering from rapid cargo diversion to Shenzhen owing to higher costs in Hong Kong. In 2002, Mainland-related entrepot trade generated nearly three times as much value added as Mainland-related offshore trade. On the average, it takes $2.1 of offshore trade to compensate for $1 decline in entrepot trade because the latter has a higher rate of value added. While the CEPA may slow the cargo diversion to Shenzhen marginally, it is unlikely to reverse such diversion. In a nutshell, in the short run, it is unlikely that the CEPA will have large beneficial effects on Mainland-related exports except for tourism. In the long run, however, the effects of the CEPA on Mainland-related services exports can be large. Though exports of financial services to the Mainland are still small, the Mainland’s financial liberalization can turn Hong Kong into an offshore centre for renminbi business. The share of income generated by all Mainland-related services exports (mostly composed of offshore trade, tourism and transportation services) to GDP has risen rapidly from 3.8 per cent in 1995 to 10 per cent in 2002, while the share of income generated by Mainland-related entrepot trade to GDP has declined slightly from a peak of 21.7 per cent in 2000 to 20.5 per cent in 2002. With the help of the CEPA, Mainland-related services exports may rival or exceed Mainland-related entrepot services in the long run. The CEPA will help to transform Hong Kong’s structure of exports away from low-end entrepot services to high-end services. There is a fear that the CEPA will increase the flow of Hong Kong entrepreneurs and professionals to the Mainland, leading to further hollowing out in Hong Kong. However, increased flows of Hong Kong entrepreneurs and professionals northward will enlarge Hong Kong’s business network in the Mainland, which is a great asset for Hong Kong as it strengthens its position as the foremost hub of China’s commerce. Moreover, the CEPA will also increase the flow of Mainland skills southward. Ultimately, Hong Kong must maintain its lead in skills and service quality in order to retain its position as the premier service hub of China. Otherwise, China’s WTO entry and the CEPA will lead only to the further hollowing out of Hong Kong services.


Breakthrough in Taiwan–Mainland links? The policy choice for Taiwan is much more complex, as it is an autonomous entity and Taipei does not want to be relegated to the status of a provincial government if it has other options. With rapid economic development on the Mainland and lethargic economic performance in Taiwan, there is an emerging consensus in Taiwan that its prohibitions on economic links hurt itself more than they do the Mainland. As mentioned before, in 2002, Taiwan liberalized on its outward investment in the Mainland and on imports from the Mainland, and began to allow investment from the Mainland. Taiwan also allowed direct trade, investment and remittances. While the liberalizations have led to a jump in Mainland-related trade and investment, the remaining restrictions are still severe and costly for Taiwan. For instance, there is no direct flight between Taiwan and the Mainland, which is costly to Taiwanese businessmen pressed for time. Direct shipping is limited to the offshore islands and the highly circumscribed shipping links between Kaohsiung’s ‘offshore transhipment centre’ and the two Mainland ports of Xiamen and Fuzhou. Despite the consensus to allow more visitors from the Mainland, the number of such visitors was not only small but also has fallen from 199 000 in 2002 to 188 800 in 2003. As mentioned in Chapter 6, both Taiwan–Mainland trade and the flow of visitors are highly unbalanced. Moreover, Taiwan’s investment in the Mainland’s service sector appears to be unusually low as a result of Taiwan’s restrictions. The share of investment in services in Taiwan’s investment in the Mainland was only 8 per cent (cumulative approved investment up to January 2004), as compared with 64 per cent for Taiwan’s investment elsewhere, 35 per cent for the Mainland’s cumulative contracted FDI, and 70 per cent for Hong Kong’s stock of investment in the Mainland (Table 6.11). Taiwan’s gross under-investment in the Mainland’s service sector will be very costly for Taiwan as the Mainland’s services liberalization scheduled from 2005 to 2007 is the focal point of Mainland’s coming wave of opening. While Taiwan wishes to enter into negotiations on direct transportation links without preconditions, the Mainland stresses that such links should be treated as domestic rather than international links. The Mainland stresses that the principle of ‘one China’, which is not accepted by Chen Shui-bian, is a precondition for talks. Though Chen was re-elected in 2004, he only won the election by a margin of less than 0.5 per cent. The election result reflected the bitter division within Taiwan over its

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relationship with the Mainland. Given this fundamental division and also the Mainland’s deep distrust of Chen, full-scale establishment of direct transportation links will not materialize soon. However, there are many restrictions that Taiwan can liberalize unilaterally without much cooperation from the Mainland. For instance, it can further relax the restrictions on imports of Mainland products and on investing in the Mainland. Even without the establishment of more direct shipping links, Taiwan can expand the size and functions of Kaohsiung’s ‘offshore transhipment centre’ to include export processing. More fundamentally, Taiwan can allow direct trade through its present shipping links between Kaohsiung’s ‘offshore transhipment centre’ and the two Mainland ports of Xiamen and Fuzhou. Taiwan can also lift its present stipulation that container cargo must change vessels in third ports. This would allow container cargo to be shipped across the Strait in chartered vessels (which must stop in a third port) in the same way as bulk cargo. This would lower the costs of Taiwan–Mainland shipping considerably. Of course, Taiwan can also relax its stringent restrictions on visitors from the Mainland and investment from the Mainland. However, relaxation of such restrictions has sensitive social, political and security implications. Given the stalemate in cross-Strait relations, the relaxation of such restrictions will probably be very gradual. This will hamper the growth of trade in services, which requires close personal contacts.

Social problems of economic integration While the economic integration of the trio has brought major economic benefits, it has also brought social and public health problems such as illegal migrant workers, crime and contagious diseases. Two opposite approaches can be taken to manage such problems. One approach is isolation; that is, severing the ties of integration. The opposite approach is management through deep integration; that is, coordination and cooperation on both sides of the border to manage the problems. While a full discussion of the two approaches is beyond this book, the well-known SARS episode can be taken to illustrate the two approaches. Taiwan took the isolationist approach. All passengers, including Taiwanese, from the Mainland and from Hong Kong, must be quarantined for 10 days on arrival in Taiwan. While there had been proponents in Hong Kong of taking the isolationist approach by sealing the border with the Mainland, Hong Kong eventually took the approach of deep


integration to manage the crisis. Cooperation between Hong Kong and the Mainland to fight SARS developed along many fronts, including border monitoring, provision of medical supplies and equipment, and joint efforts in medical research and clinical treatment. Taiwan’s isolationist approach turned out to be quite ineffective. Taiwan was the last region in the world to be removed from the list of infected areas of the World Health Organization. Taiwan’s refusal to purchase medical supplies from the Mainland exacerbated the scramble for masks in Taiwan. More seriously, Taiwan’s isolationist approach hampered learning from SARS outbreaks in Hong Kong and the Mainland, which occurred before the outbreak in Taiwan. If Taiwan had adopted the best practices then used in Hong Kong or the Mainland, its hospital outbreaks might have been avoided.7 Though Hong Kong was slow in its effort to cooperate with the Mainland to fight SARS, the belated approach of deep integration has shown encouraging results. For example, the cooperation of Hong Kong and Guangdong medical experts has led to the discovery of the coronavirus as the cause of SARS. Joint research on the animal carriers of the coronavirus and the testing of SARS vaccines have made significant progress. Hong Kong has also invited Mainland specialists in Chinese medicine to treat SARS patients in Hong Kong, and the efforts have been fruitful. The rapid spread of the avian or bird flu throughout East Asia and the Mainland in early 2004 again demonstrated that coordination through deep integration can be an effective strategy against contagious disease. The avian flu did not spread to Hong Kong despite the fact that it spread to most parts of the Mainland and East Asia, including Korea, Japan, Taiwan, Vietnam, Thailand, Cambodia, Laos and Indonesia. Importation of poultry from the Mainland was suspended for a few months, and was resumed only after thorough precautions. For instance, Hong Kong health officials were able to inspect poultry farms in the Mainland that supplied poultry to Hong Kong. To manage the social problems arising from integration in the trio, a strong case can be made that isolation is not only economically inefficient but also ineffective. Deep integration can be a much more effective strategy to control such social problems. For instance, Hong Kong has been quite successful in its coordination with the Mainland to fight cross-border crime. The same case can be made for illegal immigrant workers. For example, the Mainland authorities have restricted the right to apply for individual permits to travel to Hong Kong to the more prosperous regions as people in the Mainland’s poorer areas are more likely to work illegally in Hong Kong.

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Conclusion Hong Kong and Taiwan have played very important roles in the Mainland’s process of reform and opening. The integration of the trio started with export processing, but has since been moving towards deep integration in services. Through the reform process, the Mainland gradually shed its many practices that were inconsistent with the WTO. The deep integration of Hong Kong with the Mainland cumulated in the milestone of the CEPA. The Mainland opened its highly protected services sector selectively to Hong Kong ahead of WTO commitments. This would help the Mainland’s services industries to adapt and adjust to face the rigours of world competition. Thanks to deep integration with the Mainland, Hong Kong’s economic performance has improved decisively. Taiwan has partially liberalized its restrictions on Mainland-related trade and investment in 2002 after WTO entry. This has led to a dramatic increase in Taiwan’s Mainland-related trade and investment. However, political animosity has prevented the establishment of direct transportation links. The lack of direct transportation links, together with Taiwan’s other restrictions, has greatly limited the development of services trade between Taiwan and the Mainland. Such restrictions also have unfavourable effects on Taiwan’s investments in services in the Mainland, which are unduly small. Such restrictions are very costly for Taiwan, as services liberalization is the focal point of the Mainland’s coming wave of opening. While the economic integration of the trio has brought major economic benefits, it has also brought social and public health problems. To manage such problems, close coordination may be a more effective strategy than isolation. Unfortunately for Taiwan, the approach of close coordination is precluded by political animosity.

9 Problems and Prospects of the China Circle

While the growth of China has been extremely rapid, and there have been many rosy projections of the future, the China Circle also faces a host of problems, both economic and political. Four problems are discussed below: 1. Gross inefficiencies in Mainland’s growth. 2. Problems of adjustment to China’s export drive in the world market, especially trade frictions with the USA and other Western countries. 3. Tensions across the Taiwan Strait. 4. Maintaining prosperity in Hong Kong after 1997. After discussion of the above problems, the book will conclude with a discussion on the economic integration of Greater China and the world trading system.

Gross inefficiencies in the Mainland’s growth Though the Mainland has enjoyed spectacular economic growth since economic reforms and opening since 1979, its growth is so inefficient that it is unsustainable. The Mainland’s economy is extremely wasteful in the use of energy and raw materials, generating a very high level of pollutants. The energy used per dollar of GDP in the Mainland in 2003 was 2.4 times that of the world average, 5 times that of Germany, 4.4 times that of Japan, and 1.6 times that of India. The amount of sulphur dioxide generated per dollar of GDP in the Mainland in 2003 was 69 times that of Japan, 26 times that of Germany, and 60 times that of the USA. The Mainland’s growth has largely been based on extensive growth; that is, increase in use of inputs rather than efficiency gain. Local 210

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governments and state-owned-enterprises focus on output growth at the cost of efficiency. As a result, the Mainland’s growth has led to severe imbalances and shortages of energy and raw materials. By 2003, the Mainland had to import half of its petroleum, 44 per cent of its steel, 58 per cent of its copper, and 30 per cent of its aluminium. In early 2004, prices of raw materials in the world market jumped due to the Mainland’s insatiable demand. The Mainland surpassed Japan as the world’s second largest importer of petroleum in 2003. If present trends were to continue, the Mainland would have to import nearly all its natural resources by 2010. In early 2004, Beijing was alarmed by the bottlenecks in energy and raw materials, and it instituted a policy of macro-stabilization to slow down economic growth and also clamped down on wasteful investment projects. However, the policy only addresses the symptoms instead of the causes of the Mainland’s problems. The Mainland has to switch from a model of extensive to intensive growth, emphasizing efficiency instead of output growth. A drastic overhaul of Mainland’s growth model is required for sustainable development. This requires fundamental reforms, which are difficult and time-consuming. After over three decades of economic reforms and opening, the Mainland has reached a crossroads. Most of the easy reforms (agricultural reforms, privatization of small firms) have been completed, and the remaining reforms (increasing efficiency in use of natural resources, reform of large state-owned enterprises, banking reforms, reforms of the fiscal and monetary system) are going to be much more difficult. If China can bite the bullet and complete its reforms, then the CEA will soon rival the USA in economic strength. Otherwise, the further growth and integration of the CEA will be fraught with difficulties. Reform of services Besides severe bottlenecks in natural resources, the Mainland’s growth has also led to structural and social problems such as income maldistribution, regional inequality, and corruption. While such problems will limits China’s growth in the long run, we wish to focus on reform of services and banking reforms, which are commonly agreed to be crucial to China’s growth in the near future. Despite WTO entry in late 2001 and the gradual liberalization of Mainland services since 1992, the Mainland’s services sectors are still highly protected. While major liberalizations in sensitive sectors such as banking and finance are scheduled to take place in 2005–7, the extent of opening of these sectors to foreign investors will be limited by the


pace of the Mainland’s reforms. At present, FDI in the Mainland’s services is relatively small, except for real estate. The bulk of the FDI in the Mainland still goes to manufacturing. From 1997 to 2003, the share of manufacturing in the Mainland’s contracted FDI rose from 53 per cent to 70 per cent, while the share of other services (all services except real estate) fell from 25 per cent to 18 per cent. The expected entry of the Mainland into the WTO after the signing of the Sino–USA bilateral agreement in 1999 has obviously stimulated FDI in the Mainland. Contracted FDI in the Mainland grew by 51, 11, 20 and 39 per cent respectively in 2000, 2001, 2002 and 2003. However, it has yet to lead to a shift in the composition of FDI towards services. Reform of the banking sector The Mainland’s banking market will be open to foreign competition in 2007 and the Mainland has less than three years to clean up its banking system, which has a very high level of non-performing loans (NPLs). The official estimate of NPLs is about 20 per cent of total loans. Estimates of other sources, however, can be as high as 50 per cent (United Nations 2004:60). The high level of NPLs of the Mainland’s state banks is a reflection of the poor governance of SOEs. China’s twenty-five years of unrivalled economic growth is, in a sense, borrowed from state banks, masking gross inefficiencies in the allocation of capital. While the Mainland’s growth from 1993 to 2003 averaged 9 per cent per year, investors in the Hang Seng China Enterprise Index composed of state-owned Chinese enterprises listed in Hong Kong earned very poor or even negative returns.1 Without a fundamental reform of the banking sector, the Mainland’s rapid growth is not sustainable. China has announced a major plan of reforms for the banking sector for implementation in 2004, involving injection of public funds to recapitalize the four state banks, the transfer of NPLs to asset management companies and ownership restructuring. The success of the plan is crucial for China’s long run growth (United Nations 2004:54). Economic reforms and the Asian Financial Crisis The severity of the Asian financial crisis starting mid-1997 caught many investors and policy-makers unprepared. The crisis has taken a heavy toll. The Mainland’s stunning successes in exports and in attracting FDI eroded foreign exchange earnings in the ASEAN and contributed to the onset of the crisis. While nearly all East Asian economies have suffered greatly, the Mainland’s economy is relatively unscathed.


However, the crisis has highlighted the weaknesses in many East Asian economies, including the Chinese economy. The crisis has demonstrated the importance of thorough banking reforms and sound corporate governance. The Mainland’s banking system has the same problems with bad debts as have those of Indonesia and Thailand. The only reason that the renminbi has escaped speculative attacks is that it is not convertible. The Mainland has slowed down convertibility on its capital account as a result of the crisis. The crisis also revealed the weakness in the governance of SOEs, especially governance of China-affiliated enterprises in Hong Kong. The bankruptcy of the GITIC and related scandals dealt a severe blow to investor interests in H-shares and Red Chips in the Hong Kong market. East Asian economies have been able to achieve rapid economic growth through hard work, high savings and export-oriented industrialization. However, most East Asian economies have banking systems that are riddled by bad debts brought about by weak corporate governance and also policy loans and nepotism. Fragile banking systems have turned out to be the Achilles heels of East Asian economies, and many of them have succumbed to speculative attacks. Even an economy as advanced as Japan has a banking system that is non-transparent and riddled with bad debts and nepotism. Under the influence of the East Asian value of consensual decision-making, Japan found it difficult to punish insolvency and nepotism because that would be too harsh for the elite involved. Likewise, Japan found it difficult to clean up nepotism and corruption in its banking system. The case of Japan shows that such reforms are difficult not only because of economics, but also because these reforms require political and cultural changes that go to the heart of East Asian political culture. Among the Asian economies, Hong Kong and Singapore have transparent and sound banking and financial systems thanks to their colonial legacy. Viable and sound banking systems are rare in Asia. The Asian financial crisis again underlines the strength of Hong Kong both as an international financial centre and as the Mainland’s gateway. The role of Hong Kong as China’s gateway cannot easily be played by other cities.

Problems of adjustment in the world market Though the China Circle is not an inward-looking trade bloc, the scale of China’s entry to the world market has raised problems of adjustment in the world economy. China’s exports are concentrated on the sale of labour-intensive products to the US market. The size of the


USA–China bilateral deficit has surpassed that of USA–Japan. Though the size of bilateral trade deficits has little economic meaning and significance, it can easily lead to severe political problems and trade frictions. Protectionism is a problem for China. For instance, the number of anti-dumping charges against China is increasing very fast. Almost every year, China is high on the hit list of US Section 301 or Super 301 investigations. As a result of the scale of China’s entry to the world market, the USA has been extremely cautious in the negotiations on China’s WTO entry. As a condition for WTO membership, China has been compelled to accept three highly protectionist measures that are discriminatory and are more onerous than those imposed on any other country. First, China accepted an onerous transitional safeguard agreement for a period of 12 years from the time of its accession. Only afterwards will China be subject to the less onerous provisions of the WTO safeguard agreement. Under the special transitional safeguard agreement, importing countries can restrict surges of imports from China without the need to demonstrate serious injury to domestic producers, and the restriction can be imposed solely on China instead of on all suppliers, even when imports of the same product from other countries have also increased. Moreover, China’s ability to retaliate is more restricted than under the WTO safeguard (Lardy 2002:80–4). Second, the WTO decided to phase out the Agreement on Textiles and Clothing (ATC), which allows countries to impose quotas on textiles and apparel imports, at the end of 2004. Developing countries, especially China, should benefit as they have a comparative advantage in textiles and apparel. However, China has agreed to accept a special textile safeguard until the end of 2008. This special textile safeguard allows WTO members to restrict the import of Chinese textiles and apparel without the need to demonstrate serious injury to the domestic industry. Restrictions can be imposed even when total imports are not growing, but products from China are displacing those of other suppliers (Lardy 2002:84–5). Third, in anti-dumping, China also accepted discriminatory and onerous terms. According to WTO rules, a country can impose antidumping duties on imports if it can show that the imports are sold at less than ‘normal value’; that is, the cost of production or the price of the good sold in the home country. However, for non-market economies, the cost of production may be artificially low, and the cost of production in a third country can be used as a surrogate.


Before China’s WTO entry, China was treated by the EU and Japan as a market economy, which meant that the normal WTO rules were used for anti-dumping. However, the USA treated China as a non-market economy, which meant that a surrogate country could be used to determine the normal value. This is disadvantageous for China, as the surrogate country may have higher labour costs. Moreover, even if labour costs are the same, China may have a lower cost of production because China has a comparative advantage in producing the good. The use of the surrogate country methodology can effectively annul China’s comparative advantage. At the insistence of the USA, China has agreed to be treated as a non-market economy by WTO members in antidumping cases for fifteen years after WTO entry (Lardy 2002:86–9). To quote Nicholas Lardy, ‘[China’s] commitments on rules-based issues are especially far reaching since they give firms in other WTO member countries unparalleled opportunities to restrict inflows of Chinese goods’ (Lardy 2002:104). In a nutshell, China’s problem with protectionism is not over with WTO entry. Despite WTO entry, other WTO members can still invoke measures against China that are highly protectionist and discriminatory – measures that violate normal WTO rules and cannot be invoked against any other WTO member. If the USA or other major markets such as the EU or Japan invoke these highly protectionist measures against China indiscriminately, China’s integration into the world economy will prove very difficult. China’s ability to liberalize its imports according to its WTO commitment is conditional on its ability to expand its exports. China’s smooth integration into the world economy is thus dependent on the goodwill of the USA and other major powers. As Nicholas Lardy remarks: Perhaps the main challenge will be to maintain open markets in advanced industrial countries . . . China’s prospects of adjusting to more imports from the West will be dim if developed market economies impose restrictions on products for which they are unlikely to have a comparative advantage. Despite the scale of China’s entry to the world market, the problem on the demand side has been exaggerated. Since the relocation of the export-oriented industries of Hong Kong and Taiwan to the Mainland, the trade deficit of the USA with the Mainland has increased tremendously while the bilateral deficits of the USA with Hong Kong and Taiwan have declined.


Though the total exports of the China Circle to the USA have gone up as the relocated firms often expand in scale with the availability of cheap labour and land in the Mainland, China’s imports have also grown tremendously. Trade frictions can be avoided if China liberalizes its imports of commodities and services according to its WTO commitments. With import liberalization, China’s usual commodity trade surplus turned into a deficit in the first two months of 2004. The speculative pressure on the revaluation of the RMB also eased. After the Mainland has liberalized its imports of goods and services in accordance with WTO commitments, Hong Kong and Taiwan are unlikely to become the foremost suppliers of the Mainland. Though the Mainland may become the largest market for Hong Kong and Taiwan, the reverse is unlikely to be the case. The industrial bases in Hong Kong and Taiwan are too narrow to meet the demands of the Mainland. When the Mainland liberalizes its imports, China’s imports of final goods and consumer durables will increase relative to its import of semimanufactures, and it is likely to shift its imports away from Hong Kong and Taiwan to Japan and the West. The Mainland will have to look out of the China Circle towards East Asia and the world for its capital goods, technology and market.

Tensions across the Taiwan Strait Chen Shui-bian, candidate of the pro-independent DPP, was re-elected in 2004 by a razor-thin margin of 0.5 per cent. Since Chen will be in power till 2008, the prospect of a breakthrough in Taiwan–Mainland relations is dim. The business community in Taiwan has long supported direct links with the Mainland. The cost of Taiwan’s ban on direct transportation is much higher for passenger traffic than commodity trade because the cost of time is much higher for passenger traffic. The cost of Taiwan’s ban will increase rapidly as the Mainland is scheduled to open its services from 2005 to 2007. Services require close and frequent person-toperson contacts. Taiwan will lose a lot of business opportunities in the Mainland’s services market. However, Taiwan can make up for some of the losses through its Hong Kong connections. As mentioned before, to take advantage of the Mainland–Hong Kong CEPA, Taiwan’s approved investment in Hong Kong in 2003 nearly quadrupled over that in 2002. In 2003, Hong Kong surpassed the USA to become the second largest destination of Taiwanese outward FDI after the Mainland.


It must be stressed that the economic benefits of a breakthrough in Taiwan–Mainland relations is very high for Taiwan. Taiwan is isolated, not only diplomatically but also economically. Though Taiwan has proposed FTA agreements with many nations, including the USA, most of the proposals were turned down because of China’s opposition. Taiwan has only one FTA agreement, signed in August 2003 with Panama. The significance of such an agreement is only symbolic. If a breakthrough in Taiwan–Mainland relations is achieved, it is likely that Taiwan will be able to get its version of a CEPA with the Mainland, and the economic benefits of such a CEPA can be very substantial. However, as pro-independent sentiments are strong in Taiwan, it appears that Taiwan is willing to pay a high price to continue with the present stalemate rather than strike a compromise with the Mainland. At present, the leadership in Beijing is very pragmatic. The preparation for the 2008 Olympics in Beijing has lowered the risks of a military confrontation in the Taiwan Strait. Without a breakthrough in Taiwan– Mainland relations, Taiwan can still continue with its unilateral and partial liberalizations. Cross-Strait trade and investment will continue to grow, though by much less than the possible potential. However, it must be emphasized that the situation is not without risk. China’s preparation for the 2008 Beijing Olympics gives proindependent forces in Taiwan greater room for manoeuvre. If the Mainland perceives that the situation is getting out of hand, the use of force against Taiwan cannot be precluded. Military hostility across the Taiwan Strait would be a disaster for Hong Kong.

Stability of Hong Kong after 1997 Though Beijing has thus far largely respected Hong Kong’s autonomy, the history of ‘one country, two systems’ is too short to quieten all sceptics. The Asian financial crisis has severely tested the Hong Kong economy. To maintain competitiveness, Hong Kong must preserve its uniqueness in the rule of law, human rights and clean government. If Hong Kong becomes just another Chinese city, the economic consequence will be disastrous. However, as a result of unfavourable external factors and the misguided policy of the HKSAR government, the Hong Kong economy was in crisis from mid-1997 to mid-2003. While Beijing’s supportive measures since mid-2003 have sparked a sharp economic turnaround, there is a danger that Beijing will increasingly intervene in Hong Kong at the cost of Hong Kong’s autonomy. Beijing was alarmed by the massive half-


million-strong demonstration against the HKSAR government on 1 July 2003, the sixth anniversary of Hong Kong’s reversion to China. The demonstration fuelled a popular demand for accelerated democratization, which was opposed by Beijing. Beijing’s perception is that democracy has been used as an anti-China weapon by the DPP in Taiwan. Beijing is afraid that democratization of Hong Kong will go the same way. As a result, Beijing has intervened more actively in the debate on Hong Kong’s political reforms since late 2003. Though Hong Kong is irrevocably integrated with the Mainland, it must be remembered that it can function as the bridge linking the Mainland and the world only because it is also irrevocably integrated with the world economy. An inward-looking bloc involving Hong Kong and the Mainland would be detrimental to both. The workability of ‘one country, two systems’ lies more in the political and social realm than the economic one. The political problem is that the Mainland has to resist the tremendous temptation and pressure to intervene in the internal affairs of Hong Kong. As long as the Mainland can respect the autonomy of Hong Kong, the economic fundamentals are likely to work in Hong Kong’s favour, as it is unique among all Chinese cities in openness, international connectivity, respect for law, human rights and clean government. Moreover, there are significant economies of scale and economies of agglomeration in trading activity, and Hong Kong is competitive because it is the established centre for Mainland-related trade and investment. The competitors of Hong Kong The competitors with Hong Kong’s regional role include Singapore, Taipei and Shanghai. Singapore is a toughest competitor, as its qualities of skills, facilities and infrastructure rival those of Hong Kong. However, Singapore and Hong Kong are more complementary than competitive because they serve different regions. Hong Kong and Singapore are separated by four hours’ flight. Singapore is ideally situated to serve Southeast Asia whereas Hong Kong is better located to serve the Mainland, Taiwan, Korea or even Japan. Though both Southeast and Northeast Asia are very dynamic, the size of the Northeast Asian economy is much larger than that in Southeast Asia, and this gives Hong Kong an edge over Singapore as a regional service centre. Moreover, Hong Kong has a greater range of skills, as the size of the Hong Kong economy is 2.5 times that of Singapore. Lastly, Singapore is disadvantaged after the terrorist attack of 11 September 2001 because it is located in a Muslim region.


Taipei as a competitor to Hong Kong Taipei aspires to become a regional financial, corporate and transportation centre, and can pose a serious threat to Hong Kong because of proximity. It is located in the same region as Hong Kong and is only one hour’s flight away. Taiwan has huge investments and a big trading network throughout Southeast Asia. Although Taiwan’s investment in China is only a fraction of that of Hong Kong, Taiwan’s investment in the Mainland has grown very fast and may rival that of Hong Kong in the long run. Moreover, Taiwanese speak better Mandarin than Hong Kong Chinese, and Taiwanese businessmen are more adept at dealing with bureaucrats because of a similar business environment in Taiwan. Presently, Taipei fails to realize its potential because of the official policy of no direct links with the Mainland. Taiwan’s trade and investment with the Mainland are handled largely through Hong Kong, and Taiwan’s policy strengthens Hong Kong’s lead as a regional service centre. Taipei can be a serious competitor to Hong Kong only in the very long run when direct Taiwan–China links are fully developed. Moreover, Taipei’s service skills lag far behind those of Hong Kong and Taiwan’s heavily regulated environment is not conducive to the development of Taipei as a regional service centre. Lastly, it must be remembered that Hong Kong and Taiwan are in some ways complementary. Taiwan is stronger in engineering and industrial skills while Hong Kong is stronger in finance, shipping and legal services. Shanghai as a competitor to Hong Kong Shanghai has the advantage of location as it is situated at the mouth of the Yangzi Delta, the largest and most prosperous region in China. Although Shanghai is set to become the domestic financial centre of China, it cannot compete with Hong Kong as a regional or international centre. Shanghai cannot become a serious contender as a regional or international financial centre unless the renminbi can achieve convertibility on the capital account. Although China has achieved convertibility in merchandize trade, capital account convertibility will take much longer. The development of infrastructure and services skills is a timeconsuming and capital-intensive process. Moreover, the development of services is highly dependent on a clean, transparent and even-handed regulatory environment. Though Shanghai is developing its financial


institutions, a reputable legal framework and regulatory system takes time to evolve and mature. Given the corrupt, inefficient, and immense bureaucracy in China, the development of an efficient international service and financial centre may prove difficult. In the context of China, a reputable legal and regulatory system needs political reforms, which are more time-consuming and risky than economic reforms. Cooperation and competition As mentioned before, rapid development in the Mainland implies that there are more and more areas of competition between Hong Kong and the Mainland. In the face of stiff competition, it is imperative for Hong Kong to maintain its uniqueness among Chinese cities in openness, international connectivity, the rule of law, human rights and clean government. While Hong Kong’s costs are much higher than the Mainland’s, trading, business services and financial services are least affected by high land prices and wages because such activities are neither land-intensive nor labour-intensive. New York and London long ago lost their comparative advantage in manufacturing, but their positions in trading, business and finance remain formidable. Hong Kong’s high shares in the Mainland’s trade and investment are declining as the Mainland has built many ports, and many foreign multinationals are investing in the Mainland. However, Hong Kong will remain competitive in trade, financial and business services because of economies of scale and agglomeration. For instance, many Mainland ports have been built and managed with Hong Kong investment, and many multinationals source their logistics support from Hong Kong. The number of regional headquarters reached an all-time high of 966 in 2003 (Census and Statistics Department, 2003:24), and is likely to increase further with the implementation of the CEPA in 2004. According to a survey of multinationals conducted by The Economist Intelligence Unit (Business Asia 11 December 2000:1–4), Hong Kong is the most attractive location for headquarters of the Asian–Pacific region. The Mainland has established many trading companies in Hong Kong, showing that the territory’s efficiency in trading is well recognized. Some Hong Kong traders fear competition from Mainland trading companies in Hong Kong. However, the situation is not a zero-sum game because of economies of agglomeration – the arrival of Mainland trading companies further enhances the position of Hong Kong as a trading centre.


The China Circle and the world trading system The eighth round of multilateral negotiations on world trade in the postwar era, the Uruguay Round, was concluded in 1993, leading to the formation of the WTO in 1995. While the ninth round of multilateral negotiations started with the 1999 WTO ministerial conference in Seattle, progress has been extremely slow. The slow progress in the WTO process has encouraged the proliferation of RTAs (regional trading agreements). At the end of 2002, there were 246 RTAs in force, and another 70 RTAs were under negotiation. In the recent five years, Asian countries have started negotiations on many RTAs, accounting for over 40 per cent of the RTAs under negotiation. With import liberalization and rapid economic development, China has become a very significant market, especially for economies in East Asia. The Mainland has long been Hong Kong’s foremost market. In 2002 and 2003, Mainland’s imports increased by 21 and 40 per cent respectively. In 2003, the Mainland surpassed the USA to become the number one market of South Korea and Taiwan, and has also become a very large market for the ASEAN and Japan. In 2003, Mainland’s imports from the ASEAN, South Korea and Japan grew by 52, 51 and 39 per cent respectively. In short, China has become the engine of growth of East Asia. Given the importance of China as a market, many East Asian countries have proposed FTA agreements with China. In November 2002, China and the ASEAN agreed to form an FTA by 2010. In 2003, China signed an FTA agreement with Thailand. Singapore is negotiating an FTA with China. In mid-2003, the Mainland signed the CEPA with Hong Kong, and a CEPA with Macau followed shortly. China has agreed with Japan and South Korea to study the feasibility of an FTA, which may extend to include the ASEAN as a pan-East Asian FTA. China has proposed forming an FTA with Russia and countries in Central Asia, and has also agreed with India to study the feasibility of an FTA. In the context of the web of Mainland-centred RTAs, Taiwan will be increasingly isolated. While the prospect of a breakthrough in Mainland–Taiwan relations in the medium term (2004 to 2008) is dim, economic logic points to a political compromise and deep integration in the long run. A Greater China CEPA will then be likely to emerge. Though there are uncertainties such as the difficulties in further reforms in the Mainland, doubts on the viability of Hong Kong after 1997, and possible hostilities over the Taiwan Strait, the economic fundamentals


of the China Circle are strong. Economic forces point to a rapid continuation of economic integration of the China Circle. In 2003, the Mainland was the world’s fourth trader after the USA, Germany, and Japan. However, the Mainland’s trade was expected to surpass that of Japan in 2004 or 2005. In 2003, the exports of the CEA to the rest of the world were US$530 bn, surpassing Japan’s exports of US$472 bn. The CEA was the world’s third largest exporter after Germany and the USA. In the long run, it is likely that Greater China will emerge as the core of an East Asian FTA in a tri-polar world of the NAFTA, the EU and East Asia.

Notes 1 Greater China: An Emerging Economic Reality 1. According to Mainland statistics, Taiwan’s utilized FDI in the Mainland was surpassed by the USA and Japan in 1996. However, Taiwan’s investment in the Mainland is biased downwards significantly because Taiwan companies have to invest in the Mainland through subsidiaries established elsewhere owing to Taiwan’s ban on direct investment in the Mainland. Taiwan is most likely still the second investor in the Mainland. 2. This excludes Luxembourg, which is ostensibly the world’s foremost host of FDI because of its status as an offshore financial centre. 3. Only exports of the CEA to elsewhere are included, and intra-CEA exports are deducted. For the method of estimation, see Chapter 7.

2 China’s Opening and the Economic Integration of the China circle 1. Readers interested in a more detailed account can consult Sung 1991, chs. 1, 3 and 4. 2. This excludes Luxembourg, which is an offshore financial centre and ostensibly has the largest inflows of FDI in 2002 and 2003. 3. This is according to official figures in the World Investment Report of the United Nations. China’s outward investments are greatly understated owing to evasion of its foreign exchange controls. For details, see Chapter 5. 4. See note 2 above.

3 Policy Changes and Economic Integration 1. The exceptions are those under 18.

4 Trade Between Hong Kong and the Mainland 1. The rate of re-export margin before 1989 is assumed to be the same as that of 1989. 2. A survey of the Hong Kong Government (Census and Statistics Department, Hong Kong 1997) found that the f.o.b./c.i.f. for Hong Kong was 0.982 in 1996. As expected, the ratio for transport by land (0.991) was higher than that by sea (0.973), and the ratio for Asia (0.986) was higher than that for more distant partners such as those in North America (0.959). As Hong Kong is close to the Mainland, and a substantial portion of Hong Kong–Mainland transport is by land, the c.i.f.–f.o.b. differential of Hong Kong–Mainland trade is taken to be 1 per cent. The differential for Hong Kong–USA trade is, however, 4.3 per cent. Subsequent surveys from 1997 to 1999 revealed that the f.o.b./c.i.f. ratios are quite stable over time. 3. The proxy is biased upwards by the amount of processed exports produced by non-Hong Kong investors (for example, Taiwanese investors) that are 223

224 Notes re-exported via Hong Kong. It is biased downwards by the amount of processed exports produced by Hong Kong investors that are exported directly out of Guangdong. The biases are in opposite directions and tend to offset each other. The net bias should be small, as Hong Kong investors account for the bulk of export processing in Guangdong (Hong Kong investors accounted for 69 per cent of the cumulative FDI in Guangdong up to 2002). Moreover, of the goods from the Mainland handled by Hong Kong, the bulk (64 per cent in 2000) was imported by Hong Kong for re-export and the rest (36 per cent in 2000) exported directly as offshore trade (Table 4.3). 4. Such adjustments were first made in the Economic Report of the Hong Kong Bank, January 1991. 5. This is Guangdong’s share of Hong Kong’s imports involving outward processing from Mainland.

5 Hong Kong–Mainland Investments 1. The number-three destination, the USA, accounted for only 1.9 per cent of the stock at the end of 2002. 2. See the section ‘Subregional economic integration’ in Chapter 2 for a more detailed account of the growth triangles. 3. Hong Kong Monetary Authority, Annual Report 2002, p. 142. 4. Information obtained from interview.

6 Trade and Investment Involving Taiwan 1. Strictly speaking, the tax haven of the British Virgin Islands was in second place. However, most of Taiwan’s investment there would eventually be channelled elsewhere. 2. This fraction of 80 per cent is used by Taiwan’s Board of Foreign Trade to estimate Taiwan’s exports to the Mainland. 3. See the homepage of the Board of Foreign Trade, Taiwan (www.trade.gov.tw). 4. Except for 1996, when a surge of tourists from Japan outnumbered those from Taiwan and also the Mainland. 5. The British Virgin Islands, which is in third place in official statistics, is excluded because it is a tax haven for channelling capital from elsewhere. 6. Obtained from the website of the Investment Commission: ww.idic.gov.tw 7. British Central America is excluded as it is a tax haven for channelling capital elsewhere. 8. Ibid. 9. Combined share of ‘Real estate’ and ‘Other industries’ in Table 2.6.

7 An Overall View of Trade and Investment in the China Circle 1. Editorial Board of the Almanac of China’s Foreign Relations and Trade, 2003: 973. 2. The ratio of Hong Kong’s stock of inward FDI from the Mainland (obtained from Hong Kong data) to the Mainland’s stock of outward FDI (obtained from the World Investment Report of the UN) has always been over 80 per cent since 1994, when Hong Kong data were first available. The ratio reached a minimum of 81 per cent in 1996, probably because evasion of foreign exchange controls was then less rampant.

Notes 225 3. As mentioned in Chapter 4, according to survey data, the f.o.b./c.i.f. ratio for Hong Kong was 0.982 (Census and Statistics Department, Hong Kong 1997) and the ratio was applied to Hong Kong imports in the table. As Taiwan depends exclusively on sea transport for its trade, its ratio was taken to be 0.97, close to that for ocean transport in the survey (0.973). The Mainland’s ratio should be close to Hong Kong’s because Hong Kong is the Mainland’s foremost trading partner. The Mainland’s ratio is taken to be 0.98.

8 Policy Issues 1. Part of the Mainland’s trade not related to Taiwan at present transhipped via Hong Kong may be transhipped via Taiwan instead. However, such transhipment is very small. In 2000, other than cross-Straits related shipments, only 4.7 per cent of Hong Kong transhipments involved the Mainland ports outside Guangdong. Other than cross-Straits trade, there is very little trade to be diverted away from Hong Kong. 2. The figure of 1.1 million excludes around 1 million transit passengers who do not enter Hong Kong. The per capita expenditure of Taiwanese visitors tends to be low because the majority are ‘same-day in-town visitors’; that is, they do not stay overnight. The rate of total value added of tourist expenditure is around 0.8 for Hong Kong (Sung 2004). 3. This includes the 1 million transit passengers through Hong Kong. The rate of total value-added for air transport is 0.77 (Sung 2004). 4. Net capital outflows in 2002 and the first three-quarters of 2003 were 15.4 per cent and 12.4 per cent of the GDP respectively. 5. Individual tours reportedly accounted for close to 30 per cent of the transaction in Red Chips in Hong Kong in mid-August 2003. A prominent security company reported that the majority of its new clients in August 2003 were Mainlanders (Wen Hui Pao, 19 August 2003:A3). 6. The classification is in accordance with that of Hong Kong’s exports of services. 7. Until the outbreak in Hoping Hospital in mid-April 2003, there were no limitations placed on the number of visitors to hospitals in Taiwan.

9 Problems and Prospects of the China Circle 1. Owing to a late rally in H-shares in 2003, an initial investment in H-shares in 1993 would yield a 24.2 per cent return at the end of 2003. By comparison, an investment in the Hong Kong Hang Seng Index in 1993 would yield a return of 84.7 per cent, while the Dow Jones Industrial Index would yield a return of 188.7 per cent.

References

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References 227 Jao, Y.C. (1983) ‘Hong Kong’s Role in Financing China’s Modernization’, in Youngson, A.J. (ed.), China and Hong Kong, the Economic Nexus, Oxford University Press, Hong Kong, pp. 12–76. Kao, Chang and Sung, Yun-Wing (1995) An Empirical Study of Indirect Trade between Taiwan and Mainland China, Mainland Committee of Taiwan Government, Taipei, September (in Chinese). Kemenade, Willem Van (1998) China, Hong Kong, Taiwan, Inc., Vintage, New York. Lam, Kit Chun and Liu, Pak Wai (1998) Immigration and the Economy of Hong Kong, City University of Hong Kong Press. Lardy, Nicholas R. (2002) Integrating China into the Global Economy, Brookings Institution Press, Washington, DC. Lin, Tzong-biau and Kan, Chak-yuen (1996) ‘Chinese Firms and the Hong Kong Economy’, Asian Studies, no. 17, April, pp. 130–76 (Center for Asian Studies, Chu Hai College, Hong Kong) (in Chinese). Liu, Pak-wai (1998) ‘The Asian Financial Crisis and After: Problems and Challenges for the Hong Kong Economy’, Occasional Paper no. 89, Hong Kong Institute of Asia-Pacific Studies, Chinese University of Hong Kong, December. Liu, Qingwen (1994) ‘Hong Kong Pre-invested Enterprises Before and After 1997’, in The Hong Kong Chinese Enterprise, Hong Kong Chinese Enterprise Association, pp. 39–44. Lucas, Robert (1985) ‘The Mechanics of Economic Development’, Marshall Lecture, Cambridge University. Ming Pao, Hong Kong. Naughton, Barry (1997) ‘Economic Policy Reform in PRC and Taiwan’, in Naughton, Barry (ed.), The China Circle: Economics and Electronics in the PRC, Taiwan and Hong Kong, Brookings Institute, Washington, DC, pp. 81–110. Ni, Nick (1994) Asian Perspectives: China’s Expanding Economic Interests in Hong Kong, Nomura Research Institute Hong Kong Limited, December, 11 (no. 6). Peng, Wensheng and Shi, Joanna, Y.L. (2003) ‘External Demand for Hong Kong Dollar Currency’, Hong Kong Monetary Authority Quarterly Bulletin, March, pp. 5–15. Prasad, Eswar (ed.) (2004) ‘Hong Kong SAR: Meeting the Challenges of Integration with the Mainland’, Occasional Paper no. 226, International Monetary Fund, Washington, DC. Qiu, Hong (1996) ‘Openness and Economic Growth in China’, MPhil. thesis, Chinese University of Hong Kong (mimeo). Scalapino, Robert A. (1992) ‘The United States and Asia: Future Prospects’, Foreign Affairs, Winter 1991/92, pp. 19–40. Shen, George (1993) ‘China’s Investment in Hong Kong’, in Choi Po-king and Ho Lok-sang (eds), The Other Hong Kong Report 1993, Chinese University Press, Hong Kong, pp. 425–54. Sing Tao Daily, Hong Kong. South China Morning Post, Hong Kong. Sung, Yun-Wing (1991) The China–Hong Kong Connection: The Key to China’s OpenDoor Policy, Cambridge University Press. Sung, Yun-Wing (1992) ‘Non-institutional Economic Integration via Cultural Affinity: The Case of Mainland China, Taiwan, and Hong Kong’, Hong Kong Institute of Asia-Pacific Studies, Chinese University of Hong Kong, Occasional Paper no. 13, July.

228 References Sung, Yun-Wing (1996) ‘Chinese Outward Investment in Hong Kong: Trends, Prospects, and Policy Implications’, OECD Development Centre, Technical Papers no. 113, July. Sung, Yun-Wing (1998) Hong Kong and South China: The Economic Synergy, City University of Hong Kong Press. Sung, Yun-Wing (1999) ‘Shanghai and Hong Kong as Service Hubs’, Occasional Paper no. 102, Hong Kong Institute of Asia-Pacific Studies, Chinese University of Hong Kong, December. Sung, Yun-Wing (2001) ‘Export-Oriented Foreign Direct Investment in the People’s Republic of China: Division of Value Added between Source and Host Economies’, in Cheng, Leonard K. and Kierzkowski, Henryk (eds), Global Production and Trade in East Asia, Kluwer, Boston, pp. 207–25. Sung, Yun-Wing (2003) ‘The Mainland–Hong Kong Closer Economic Partnership Arrangement’, Occasional Paper no. 135, Hong Kong Institute of Asian Pacific Studies, Chinese University of Hong Kong, April (in Chinese). Sung, Yun-Wing (2004) ‘Hong Kong’s Economic Integration with the Pearl River Delta: Quantifying the Benefits and Costs’ (mimeograph). Sung, Yun-Wing, Liu, Pak-Wai, Wong, Yue-Chim Richard and Lau, Pui-King (1995) The Fifth Dragon: The Emergence of the Pearl River Delta, Addison-Wesley, Singapore. Sung, Yun-Wing and Wong, Kar-yiu (2000) ‘Growth of Hong Kong Before and After Its Reversion to China: The China Factor’, Pacific Economic Review, 5 (2), pp. 201–28. Tom, C.F. (1957) Entrepot Trade and the Monetary Standards of Hong Kong, University of Chicago Press. Tsai, Horng-Ming (2002) ‘The Impact on Hong Kong of Three Links across the Taiwan Strait’, Paper presented to the Conference on the Situation of Hong Kong on the Fifth Anniversary of the Handover and the Relationships Among the Three Regions of the Taiwan Strait organized by the Association of the Friends of Chinese Hong Kong and Macau in Taipei from 28 to 29 September, 2002 (in Chinese). United Daily News, Hong Kong. United Nations (2003) World Investment Report 2002, New York. United Nations (2004) World Economic Situation and Prospects 2004, New York. Wakabayashi, Masahiro (1990) ‘Relations Between Taiwan and China During the 1980s, Viewed from the Taiwan Perspective’, Jetro’s China Newsletter, no. 87, July–August, pp. 6–16. Wang, Xianzhang (1994) ‘Expand Insurance Business at an Accelerated Speed’, Hong Kong Chinese Enterprise, Hong Kong Chinese Enterprise Association, pp. 50–5. Wei, Shang-Jin (1995) ‘The Open Door Policy and China’s Rapid Growth: Evidence from City-Level Data’, in Ito, Takatoshi and Krueger, Anne (eds), Growth Theories in Light of the East Asian Experience, University of Chicago Press, pp. 73–104. Wei, Shang-Jin (1996) ‘How Taxing Is Corruption on International Investors?’ (mimeograph). Wen Hui Pao, Hong Kong.

References 229 World Bank (1983) China: Socialist Economic Development, World Bank, Washington, DC. World Bank (1994) China: Foreign Trade Reforms, Washington, DC. World Trade Organization (2003) World Trade Report 2003, World Trade Organization, Geneva. Xu, Jiatun (1993) ‘Xu Jiatun Hong Kong Memoir’, Hong Kong United Daily (in Chinese). Xu, Xing (2002) ‘Taiwan’s Huge Investments in the Mainland’, Open Magazine, Hong Kong, July, pp. 41–3 (in Chinese). Yamamura, Kozo (1976) ‘General Trading Companies in Japan: Their Origins and Growth’, in Patrick, Hugh (ed.), Japanese Industrialization and Its Social Consequences, University of California Press, Berkeley. Yeh, Milton (1995) ‘Ask a Tiger for its Hide? Taiwan’s Approach to Economic Transaction across the Straits’, in Khanna, Jane (ed.), Southern China, Hong Kong, and Taiwan, Center for Strategic and International Studies, Washington, DC, pp. 61–70.

Index Agreement on Textiles and Clothing (ATC) 181, 214 see also Multi-Fibre Arrangement (MFA) airports 189 see under individual names: Hong Kong, Guangzhou, Macau, Shenzhen, Zhuhai Asian Development Bank 46 Asian Financial Crisis 5, 8, 20, 25, 55, 56, 179, 197, 212–13 effects on Hong Kong 6, 77, 115–16, 131, 186 effects on Mainland 139, 212–13 Asian-Pacific Economic Community (APEC) 71 Association of Hong Kong Chinese Enterprises 126, 128 Association of South East Asian Nations (ASEAN) 8, 9, 24, 43–4, 120, 139, 163, 173–5, 221 Association for Relations Across the Taiwan Straits (ARATS) 64 avian flu 208 Bandung Conference 69 Bank of China (BOC) 114, 115, 123, 126, 131, 134 Bank of East Asia 134, 183 Basic Law 57 Beijing 6, 104, 186, 190, 193, 194, 217 border checkpoints 191–2 see under individual names: Lok Ma Chau-Huangang Crossing, Lowu, Western border Crossing British Virgin Islands 110–12, 125, 165 Brunei 44

Cambodia 208 capital account convertibility 55, 213, 219 Cathay Pacific 135 CEA see Chinese Economic Area CEPA (Closer Economic Partnership Arrangement) 6, 40, 45, 56, 71, 93, 113, 174, 183, 187, 199–205, 216, 217, 221 Census and Statistics Department 75 Chan, Anson 187 Chen Shui-bian 6, 15, 67, 70, 179, 206, 216 Cheng An Kuo 69 Cheng Leung-jen 69 Cheung Kong Holding 113 China banking reform 212 economic reforms 18–20, 211–13 exports 9, 20 foreign investment 20–30, 180, 181, 212 relations with USA 61 state-owned enterprises 211 trade 35–9, 180, 181–2, 221 trade with USA 9, 17, 55, 74–7, 213–14 services liberalization 35–39 see also Mainland China Aerospace corporation 129 China-Affiliated Corporations Index 115–16, 212 see also Red Chips Index China Arts and Crafts 123 China Circle 1, 2, 9 economic indicators 10 economic integration 43–4, 221–2

230

Index 231

China Circle continued impacts on world economy 7–9 see also Chinese Economic Area China Customs Statistics 168 China Everbright Company 130 China Insurance Holdings Company 126 China International Trust and Investment Company (CITIC) 126, 128, 129, 130, 134, 135 China Merchants Company 2, 123, 126–7, 131, 132, 133, 134 China Poly Group 129 China Resources Company 123, 126, 127, 131, 132, 133 China Travel Service 123, 127, 131, 132, 133 China Venturetech 129 Chinese Economic Area (CEA) 2, 5, 9, 222 economic integration 10, 71–2 intra-CEA trade 167–75, 178 intra-CEA investment 163–7, 176, 178 see also China Circle Clinton, Bill 197 clothing quota 99 coastal development strategy 63 Cold War 47, 61 Common market 42 Conic Investment 131 Continental Mariner 129 co-operative ventures 21 customs union 42 customs territory 45, 193, 199 Democratic Progressive Party (DPP) 7, 15, 67, 70, 216 Deng Xiaoping 3, 21, 25, 46, 53, 61, 72, 82, 112, 113, 120, 129, 131 Deng Zifang 129, 131 Dongguan 182, 192 Dongjiang 191 Dragonair 135

duo (Hong Kong and Taiwan) 5, 172–3, 174, 176 contribution to Mainland’s exports 2 investment in Mainland 31–2 role in Mainland’s opening 3–4 economic integration 41–5, 71–2 economic union 43 economies agglomeration 106, 133, 185, 220 external 106 scale 106, 183 Euro 45 European Currency Units 126 European Economic Community (EEC) 43 European Union (EU) 4, 43, 45, 71, 163, 172, 173–5, 177, 222 trade with Hong Kong 97–9, 215 export-processing 51, 52, 121–2, 176 see also processing operations foreign exchange controls 16, 51, 56 foreign investment environment 24, 176 foreign-funded enterprises 21, 25–6 from Hong Kong in Mainland 25–32 from Taiwan in Mainland 25–32 in China 20–35 in/from Hong Kong 110–11 loans 21–4 other foreign investment 21 Formosa Plastics 139 France 194 free trade area (FTA) 6, 42–3, 71, 199, 217, 221 Fujian 2, 12, 139, 140 Fung King Hey 134 Fuzhou (Fujian) 65, 206

232 Index

Gaolan (port) 189, 190 General Agreement on Tariff and Trade (GATT) 41–2 Germany 222 greater China see Chinese Economic Area, China Circle greater Hong Kong 9, 43–4 greater Southeast China (GSC) 9, 10, 12, 14, 140 Greece 45 growth triangles 43, 44 Guam 142 Guangdong 2, 10, 12–13, 46, 53, 190, 193, 194, 201 investment from Hong Kong 52, 117–21 investment from Taiwan 139, 140 services trade with Hong Kong 202 trade with Hong Kong 94–5 Guangdong Enterprise 127, 128, 129, 131, 132, 133 Guangdong International Trust and Investment Company (GITIC) 24, 116, 213 Guangzhou 6, 50, 104, 128 airport 189, 190 H-shares 115–16, 131, 195, 196, 198, 213 Hainan 3 Hang Seng Futures Exchange 134 Hicks, John 106 Hong Kong 213, 217–20 cargo hub of Mainland 104–6 coordination with Guangdong 187 coordination with Mainland 186–99 effects of Asian Financial Crisis 6 effects of direct TaiwanMainland links 184–6 entrepot trade 49, 77–88, 92–9, 205 investment in Mainland 1, 8, 16, 25–32, 55, 109–22, 165

investment in Guangdong 44, 52, 117–21 investment from Mainland 16, 54, 123–36, 164–5 investment in/from Taiwan 156–60, 165–6 loans to Mainland 113–15 middleman of Mainland 104–7, 183–4 population policy 58 production network in Guangdong 95–100 relations with Mainland 1, 47–60, 186–9 relations with Taiwan 68–71 services trade with Mainland 99–104, 178, 200–2, 204–5 services trade with Guangdong 202 trade, outward processing 88–92, 94–9 trade with Guangdong 94–5 trade with Mainland 8, 49–50, 73–108, 167–73, 200, 203–4 trade with Taiwan 186–9 trade statistics 74–7 tourists, on individual tours 6, 56, 60, 187, 193–5, 198 tourist trade with Mainland 101–2, 193–4, 204 tourist trade with Taiwan 185 unemployment 56 Hong Kong Airport 189, 190, 191 Hong Kong and Shanghai Bank see HSBC Hong Kong Bank see HSBC Hong Kong Disneyland 195 Hong Kong/Guangdong Cooperation Joint Conference 186–8, 191, 195 Hong Kong International Terminals Limited (HIT) 190 Hong Kong–Mainland Cross Boundary Major Infrastructure Coordinating Committee 190, 193

Index 233

Hong Kong Monetary Authority 45, 196, 198 Hong Kong Telecom 135 Hong Kong Trade Development Council 69, 183 Hong Kong–Zhuhai-Macau bridge 6, 188, 191, 192 HSBC (Hong Kong Bank) 55, 125, 126, 134, 183, 196 Hu Jintao 187 Hua Nan Commercial Bank 69 Huang Huahua 188 Huizhou (port) 189 Hutchison-Whampoa 55, 105, 113 illegal direct shipment 144 immigrants 45, 47, 50–3, 57–60 India 35–6, 44, 221 Indonesia 44, 208 infrastructure 189 see also airports and ports Ireland 45 Japan 5, 7, 8, 120, 173, 178, 208, 213, 215, 221, 222 investment in China 25–8, 166, 177 investment in Hong Kong 125, 127 investment in/from Taiwan 157 trade with China 153 trade with Hong Kong 97–9, 157 trade with Taiwan 156 Jarkata 69 Jiangsu 12–14, 118, 120, 140 Jiang Zemin 64, 187 Jieji Yongren policy (‘no haste, be patient’) 66, 67, 184 joint ventures 21 Ka Wah Bank 126, 131 Kadar Investment 129, 131 Koahsiung 65, 161, 207 Koo Chen-fu 64 Korean War 47, 49, 61

Kowloon Wharf 113 Kuomintang (KMT) 67, 70 Laws Property 129 Lee Teng Hui 64, 66, 69 Li Ka-shing 129 Liu Shaoqi 130 Lok Ma Chau-Huangang Crossing 192 London 183, 220 Lowu (border crossing) 192 Macau 2, 6, 11, 192, 221 airport 65 Mainland direct links with Taiwan 184, 208 Mainland–Hong Kong CEPA see CEPA investment from Hong Kong 16, 109–22 investment from Taiwan 16, 137–41, 166 investment in Hong Kong 8, 16, 123–36 loans from Hong Kong 113–15 relations with Hong Kong 47–60, 186–99, 217–18 relations with Taiwan 61–8, 184, 206–7, 216–17 services trade with Hong Kong 99–104, 178 services trade with Taiwan 156 tourist trade with Hong Kong 101–3 trade statistics 74–5 trade via Hong Kong 93–4 trade with Hong Kong 8, 16, 49–50, 73–108, 167–73 trade with Hong Kong itself 42–93 trade with Taiwan 8, 64, 153–5, 167–73 see also China Malaysia 44 Mekong River Basin Project 44 Mexico 44

234 Index

Ministry of Communications (of China) 2 Ministry of Foreign Trade and Economic Cooperation (MOFTEC) 199 Ministry of Transport 191 Most Favoured Nation (MFN) 42 see also Normal Trade relations, NTR Multi-fibre Arrangement (MFA) 36 see also Agreement on Textiles and Clothing, ATC Nansha 195 natural economic territories 43 Netherlands 96, 125 New China News Agency (NCNA) 127, 129, 134 New World 113 New York 183, 220 Ni, John 69 Normal Trade Relations (NTR) 181, 199 see also Most Favoured Nation, MFN North American Free Trade Area (NAFTA) 43, 71, 163, 173–5, 222 North Korea 46 Okinawa 142 one country, two systems 54, 61, 71, 186, 217 Ong Group 129

3, 14,

Panama 217 PCCW (Pacific Century Cyber Works) 55 Pearl River Delta (PRD) 6, 8, 185, 188, 189, 191, 192, 193, 195 People’s Bank of China 196 People’s Liberation Army (PLA) 129 Philippines 44 Planning Commission (of China) 191

port facilities 188 see under individual ports: Huizhou, Gaolan, Shekou, Yantian, Shenzhen processing operations 21–3, 25–6 see also export processing protectionism 214–5 Pudong 12 see also Shanghai Pusan (Korea) 142 qualified domestic institutional investor (QDII) scheme 197 quota (clothing) 99 Red Chips Index 115–16, 131, 196, 198, 213 see also China-Affiliated Corporations Index re-export margin 75–7, 84, 101, 121 regional operations center 66 regional trading agreements (RTA) 221, 42–3 Renminbi 198, 219 Renminbi business 56, 181, 188, 196–7 Russia 221 SARS (Severe Acute Respiratory Syndrome) 7, 15, 56, 179, 181, 206–7 Shanghai 6, 9, 12, 77–80, 104, 105, 118, 120, 140, 190, 194, 219–20 see also Pudong Shantou (Special Economic Zone) 2 Shekou (port) 2–3, 189, 190 Shenzhen 2–3, 4, 6, 10, 45, 46, 104, 105, 189, 193, 195 Airport 189, 190, 191, 192 shipping direct 80, 82 transit shipment 144 transhipment 80–2, 144, 184, 206, 207

Index 235

Shougang Corporation 129 Singapore 19, 120, 125, 142, 159, 195, 213, 218, 221 Sino-British Agreement/ Declaration on Hong Kong 45, 54, 70 Sino-British dispute (on Patten proposals) 190 Sino-Soviet rift 49 South Korea 19, 153, 181, 186, 195, 221 Southeast Economic Information Centre 133 Soviet bloc 49 Soviet Union 46 Special Administrative Region (SAR) 45, 47, 134 Special Economic Zone (SEZ) 2, 16 see under individual zones: Hainan, Shantou, Shenzhen, Xiamen, Zhuai Standard Chartered Bank 126, 134 State Council (of China) 191, 195, 197 state owned enterprises 13 stock market 115, 116, 196 see also H-shares Straits Exchange Foundation (SEF) 64 subregional economic zone 43 Sun Hung Kai Properties 113 ‘Super 301’ 214 Suzhou 182 Swire Pacific and Peninsular & Oriental Stream Navigation Co (P&O) 190 switch bills 142–7 syndicated loans 115, 116 Taipei 66, 69, 161 Taiwan 7, 61, 195, 208, 221 imports from Mainland 65, 67 investment from/in Hong Kong 156–60, 165–6, 203, 216 investment from Mainland 206

investment in Mainland 1, 8, 16, 25–32, 65, 67, 137–41, 166, 184, 206 relations with Hong Kong 68–71 relations with Mainland 61–68, 184, 206–7, 216–17 services trade with Mainland 156, 206 trade with Hong Kong 150–60, 167–73, 203 trade with Mainland 8, 17, 67, 141–53, 167–73, 184 trade with Guangdong 185 see also Taipei Tax Haven economies 25–8, 125, 139 Thai baht 44 Thailand 44, 208, 221 ‘Three Noes Policy’ 61, 64, 65, 68 Tiananmen incident 24, 31, 46 trade entrepot 49, 77–88 intra-CEA 167–75, 178 liberalization 216 offshore 80–84, 205 outward-processing 88–92, 94–9 protectionism 214–15 trade-partners statistics technique 145 transfer pricing 122 transnational export processing zones 43 transhipment 80–2, 184, 206, 207 Treaty of Rome 43 Tumen River 43, 46 Tung Chee-hwa 70, 134, 187, 188 Tung, C.Y. 134 ‘two states theory’ 66, 69 Union Bank 126, 134 Union Globe Development 131 United Kingdom (UK) 125 United Nations 49

236 Index

USA

5, 7, 9, 20, 43, 49, 55, 62, 66, 138, 172, 178, 217, 222 investment in China 25–8, 166, 177 investment in Hong Kong 97–9, 157, 173 investment in/from Taiwan 157, 159, 203 trade deficit with China 9, 17, 55, 74–7, 198, 214, 215 trade with China 55, 153 trade with Hong Kong 97–9, 157, 173 trade with Taiwan 156, 173

ventures co-operative 21 joint 21 wholly foreign-owned 21 Vietnam 208 Wang Daohan 64 Wang Guanying 130 Wang-Koo talks 64, 66 Western Border Crossing 192 World Trade Organization (WTO) 5, 15, 42, 67, 104, 156, 179, 188, 199, 221

Doha Ministerial Conference 187 China’s commitments 39–40, 54, 63, 162, 180, 200, 201, 211 effects on China 20, 25, 35, 113, 116, 180–2, 212, 214–15 effects on Hong Kong 181–6 effects on Taiwan 181–6 Sino–US Agreement on China’s entry 25, 212, 214–15 Xiamen 2, 65, 139, 206 Xu Jiatun 129–30, 134 Yangzi Delta 9, 12, 120, 185, 219 Yantian (port) 105, 189, 190 Ye Jianying 61 Yue Xiu Group 128 Zhao Ziyang 134 Zhejiang 11, 14, 140 Zhonghua Travel Service 69 Zhongshan 192 Zhuhai 2, 6, 189, 192, 193 airport 189, 190, 191

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International Joint Ventures in China (Studies on the Chinese Economy)

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Perspectives on the Yi of Southwest China (Studies on China)

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Neoliberalism and Culture in China and Hong Kong: The Countdown of Time (Routledge Contemporary China Series)

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