HONG KONG 2005

With its strategic location at the doorway to the Mainland and in a time zone that bridges the gap between Asia and Europe, the Hong Kong Special Administrative Region (HKSAR) serves as a global centre for trade, finance, business and communications. Hong Kong is now the 11th largest trading entity in the world. It operates one of the busiest container ports in the world in terms of throughput, as well as one of the busiest airports in terms of number of passengers and volume of international cargo handled. In addition, it is the world's 15th largest banking centre in terms of external banking transactions, and the sixth largest foreign exchange market in terms of turnover. Its stock market is Asia's second largest in terms of market capitalisation.

Hong Kong is characterised by high degree of internationalisation, a business-friendly environment, the rule of law, free trade and the free flow of information, open and fair competition, a well-established and comprehensive financial network, a superb transport and communications infrastructure, sophisticated support services and a well-educated workforce complemented by a pool of efficient and enterprising entrepreneurs.

Added to these are the substantial amount of foreign exchange reserves, a fully convertible and stable currency, prudent fiscal reserves and a simple tax system with low tax rate. With these virtues, Hong Kong is widely regarded as amongst the freest and most competitive economies in the world. The US Heritage Foundation ranked Hong Kong as the world's freest economy for the 11th year in a row in its '2005 Index of Economic Freedom'. The Cato Institute of the United States, in conjunction with the Fraser Institute of Canada and other research bodies around the world, also consistently rank Hong Kong as the freest economy in the world.

Over the past two decades, the Hong Kong economy has nearly tripled in size, with GDP growing at an average annual rate of 5.3 per cent in real terms. This outpaces both the world economy's growth of 3.6 per cent and the 2.8 per cent growth of the Organisation for Economic Cooperation and Development (OECD) economies by a large margin. Over the same period, Hong Kong's per capita GDP has doubled, giving an average annual growth rate of 4 per cent in real terms. At US$25,600, Hong Kong's per capita GDP was amongst the highest in Asia in 2005 (Chart 1).

In line with the Hong Kong economy's increased openness amid the growing influence of globalisation, trade in goods expanded more than eight times and trade in services more than three times in real terms over the past two decades. In 2005, the total value of visible trade (comprising re-exports, domestic exports and imports of goods) reached $4,563 billion, equivalent to 330 per cent of GDP. This was considerably larger than the ratios of 167 per cent in 1985 and 252 per cent in 1995. If the value of exports and imports of services is also taken into account, the ratio is even greater, at 383 per cent in 2005, as compared to 205 per cent in 1985 and 291 per cent in 1995.

The stock of inward direct investment in Hong Kong which amounted to $3,522 billion in market value at the end of 2004, equivalent to 273 per cent of GDP, was another strong indication of Hong Kong's increasingly international focus. Hong Kong is the second most favoured destination for inward direct investment in Asia, next only to the Mainland.

The corresponding figures for the stock of outward direct investment in Hong Kong were likewise substantial, at $3,134 billion and 243 per cent, much larger than those for many other economies in Asia. As a major financial centre in the region with huge cross-territory fund flows, Hong Kong's external financial assets and liabilities were also substantial, at $11,657 billion and $8,175 billion respectively at the end of 2005. The corresponding ratios to GDP in that year were 843 per cent and 591 per cent. Reflecting Hong Kong's sound international investment position, net external financial assets amounted to $3,482 billion at the end of 2005, equivalent to 353 per cent of GDP. As for gross external debt, which is the sum of the non-equity liability components in international investment, it stood at $3,464 billion at the end of 2005, equivalent to 251 per cent of GDP. Most of it arose from normal operations of the banking sector.

The Gross National Product (GNP), comprising GDP and net external factor income flows, stood at $1,385 billion in 2005. This was slightly higher than the corresponding GDP by 0.2 per cent. The difference represented a net inflow of external factor income. In gross terms, inflows and outflows of external factor income remained substantial in 2005, at $503 billion and $501 billion respectively, both equivalent to 36 per cent of GDP. This was related to the huge volume of both inward and outward investment in Hong Kong.

Structural change is nothing new to the Hong Kong economy. The past decades have seen constant changes brought about by the rapid developments in the regional and global economic environment. In the 1950s Hong Kong was a thriving entrepôt but it swiftly remade itself into an important manufacturing base serving the world market in the 1960s and 1970s. It then further diversified and evolved into a regional financial centre and a business-cum-trading hub in the 1980s. It was also quick to recognise the opportunities presented by the opening up of the Mainland economy in the late 1970s and has played the key role of middleman between the Mainland and the rest of the world, channelling trade and investment flows into and out of the Mainland. In addition, by relocating production facilities across the boundary, as well as investing in this major economic hinterland on a large scale, Hong Kong entrepreneurs have helped transform South China into the world's largest and fastest growing 'factory'.

By meeting the challenges of rapid technological change and the increasingly intense competition brought about by globalisation, the Hong Kong economy has been moving up the value-added chain, shifting towards higher value-added services and more knowledge-based activities.

The rising living standards of Hong Kong people over the decades is a clear testament to their capacity to adapt to rapid changes with the support from sound and effective market institutions. Structural change is an ongoing process, especially with ever-expanding globalisation.

In recent years, the Hong Kong economy has continued to explore the advantages in 'leveraging the Mainland and engaging ourselves globally'. For instance, the focus of Hong Kong's trade has gradually shifted from re-exports to supply-chain management and high value-added logistics services, which has resulted in offshore trade flourishing. Hong Kong's financial markets have not only become the major fund-raising channel for Mainland enterprises, they are also playing a facilitating role in helping them upgrade corporate governance, enhance operational efficiency, promote brand names and go global. Hong Kong's professionals are playing an active role in providing professional services to the Mainland economy, both contributing to and gaining substantially from the Mainland's new phase of economic development.

The success of the Hong Kong economy in meeting the challenges and seizing the opportunities arising from structural changes has always depended, and will continue to depend, on its people. A better-educated and more highly skilled workforce is the key to the flexibility and resilience of the economy. Over the past decade, Hong Kong's labour force has been growing at an average annual rate of 1.6 per cent, but the higher-skilled, professional and managerial component of the labour force has been growing at a much faster average annual rate of 4 per cent. Today, one out of three people in Hong Kong's labour force belongs to this vibrant group of workers.

Primary production (including agriculture, fisheries, mining and quarrying) is insignificant in Hong Kong, in terms of both its value-added contribution to GDP and share in total employment. This reflects the predominantly urban economy.

Secondary production (comprising manufacturing, construction, and supply of electricity, gas and water), which made a significant contribution to GDP up to the early 1980s, has since diminished in importance. Within this broad sector, the value-added contribution from manufacturing shrank from 23 per cent in 1984 to 9 per cent in 1994 and to only 4 per cent in 2004 as a result of the ongoing relocation of the more labour-intensive production processes to the Mainland. The contribution of the construction sector to GDP stayed at around 5 per cent between 1984 and 2000, before edging down to 3 per cent in 2004. The supply of electricity, gas and water held relatively stable, with a share of around 2-3 per cent of GDP over the past two decades.

The Mainland's open-door policy and economic reform have not only provided an enormous production hinterland and market outlet for Hong Kong's manufacturers, they have also created abundant business opportunities for a wide range of services.

These include freight and passenger transport, travel and tourism, telecommunications, banking, insurance, real estate, and professional services such as financial, legal, accounting and consultancy services. As a result, the Hong Kong economy has become increasingly service-oriented since the 1980s. This is also indicative of the ongoing restructuring of the economy towards more knowledge-based and higher value-added activities amid the challenges of globalisation.

Reflecting this, the share of the tertiary services sector (comprising the wholesale, retail and import/export trades; restaurants and hotels; transport, storage and communications; finance, insurance, real estate and business services; community, social and personal services and ownership of premises) in GDP went up visibly, from 68 per cent in 1984 to 84 per cent in 1994 and 90 per cent in 2004 (Chart 2).

There was a similar development on the employment front, underpinned by a flexible labour market and the continuous improvement in the quality of the local workforce. The service sectors as a whole enlarged their share in total employment from 82.7 per cent in 2000 to 86 per cent in 2005. In contrast, the share of the manufacturing sector shrank from 7.1 per cent to 5.3 per cent and that of the construction sector from 9.4 per cent to 8 per cent over the same period (Chart 3). The continuous upgrading of the quality and educational attainment of the local workforce, together with the flexibility of the labour market, has enabled such restructuring to proceed more smoothly than it might have done.

The service sector has not only flourished but also diversified to match economy's structural transformation. Trade-related and tourism-related services, community, social and personal services, and finance and business services such as banking, insurance, real estate and a host of related professional services, have all grown significantly over the past two decades. Information technology (IT) has also expanded considerably in more recent years — especially IT related to telecommunications services and Internet applications — in line with the shift in the economic structure towards more knowledge-based activities.

Between 1994 and 2004, the net output of the service sector as a whole rose by an annual average of 3 per cent in value terms. Among the major constituent sectors, net output of community, social and personal services had the fastest growth (at an average annual rate of 6 per cent). This was followed by the wholesale, retail and import/export trades, restaurants and hotels; and transport, storage and communications (both at 4 per cent); and finance, insurance, real estate and business services (1 per cent).

In 2004, the wholesale, retail and import/export trades, restaurants and hotels continued to be the largest service sector, accounting for 27 per cent of value added contribution to GDP. This was followed by finance, insurance, real estate and business services (21 per cent), community, social and personal services (21 per cent), and transport, storage and communications (10 per cent) (Chart 4).

The profound structural change in the economy was paralleled by a shift in the sectoral composition of employment. Over the past two decades, the service sector's share in total employment went up from 54 per cent in 1985 to 78 per cent in 1995 and 86 per cent in 2005 with wholesale, retail and import/export trades, restaurants and hotels accounting for 34 per cent of the total. Community, social and personal services followed with a share of 26 per cent, and then finance, insurance, real estate and business services (15 per cent), and transport, storage and communications (11 per cent) (Chart 5).

Hong Kong's manufacturing sector is expected to continue to be versatile and flexible in coping with the changing environment. While the productive capacity has effectively been expanded by multiples through increased outward processing arrangements in the Mainland, Hong Kong's productive efficiency and product quality are also expected to be continuously upgraded by advances in technology and a shift towards production with a more knowledge-based and higher value-added content.

As the more labour-intensive production processes have gradually moved to the Mainland over the past decade, manufacturing has taken a back seat. Manufacturing output made up 16.7 per cent of Hong Kong's GDP in 1990 which declined to 5.4 per cent in 2000 and 3.5 per cent in 2004. In the local manufacturing sector, paper products and printing contributed the largest share of net output to the sector — 26 per cent — in 2004, followed by textiles and clothing with a 22 per cent share. Other major industries included machinery and equipment, electronics, food processing and metal products.

After the decline of the past decade or so, there was a small turnaround in the activity of the manufacturing sector, with its net output or value added rising back by 1.7 per cent in real terms in 2004. In 2005, there was a further year-on-year increase of 2.1 per cent in real terms. It is conceivable that the Closer Economic Partnership Arrangement (CEPA), which has given tariff-free treatment to certain products of Hong Kong origin since January 1, 2004, has boosted Hong Kong's manufacturing sector a little. However, since the textile and clothing (T&C) quota was abolished under the World Trade Organisation (WTO) on January 1, 2005, there have been heightened uncertainties over possible safeguard measures imposed by the European Union and the United States on the Mainland's T&C exports, prompting some increase in clothing production in Hong Kong from mid-2005. Overall, improved labour productivity plus technology upgrading has meant fewer jobs in the sector. In 2005, the sector employed around 178 800 people, slightly down from 2004.

The strengthening economic links between Hong Kong and the Mainland since the latter adopted the open door policy in 1978 have brought substantial mutual benefits. The flow of goods, services, people and capital between Hong Kong and the Mainland and between the Mainland and the world via Hong Kong have created a remarkable growth in income and employment opportunities in both Hong Kong and the Mainland over the years.

Visible trade between Hong Kong and the Mainland has expanded 190 fold since 1978, at an average annual rate of 21 per cent in value terms. The growth remained appreciable in 2005, at 14 per cent (Chart 6). The previous year, along with such strong growth in bilateral trade, Hong Kong ranked the 11th and the Mainland the third largest trading entity in the world.

The Mainland has long been Hong Kong's largest trading partner, accounting for 45 per cent of the total trade value in Hong Kong in 2005. Ninety-one per cent of Hong Kong's re-export trade was related to the Mainland, making it the largest market for, as well as the largest source of, Hong Kong's re-exports. Reciprocally, Hong Kong was the Mainland's third largest trading partner (after the US and Japan), accounting for 10 per cent of the Mainland's total trade value in 2005.

Hong Kong is also a principal gateway to or from the Mainland for business and tourism. Between 1996 and 2005, the number of trips made by Hong Kong residents to the Mainland more than doubled, with an average annual growth rate of 9 per cent to 63 million trips. The number of trips made by foreign visitors to the Mainland through Hong Kong rose by a cumulative 77 per cent over the same period, with an average annual growth rate of 7 per cent to 4 million trips. In 2005, these two types of trips to the Mainland rose by 5 per cent and 10 per cent respectively. The number of trips made by Mainland residents to or through Hong Kong rose more than five fold, with an average annual growth rate of 20 per cent between 1996 and 2005 to 12.5 million trips. The growth moderated to 2 per cent in 2005, reflecting the slower growth in the Mainland's outbound tourism.

Hong Kong continues to be the largest external investor on the Mainland. According to the Mainland's statistics, the cumulative value of Hong Kong's realised direct investment on the Mainland reached US$260 billion at the end of 2005, accounting for 42 per cent of the total inward direct investment there. Over the years, there has been a noticeable shift in the composition of Hong Kong's direct investment across the boundary, from industrial processing to a wider spectrum of business ventures, such as hotels and tourist-related facilities, and real estate and infrastructure development. Compared to other places in the Mainland, Hong Kong's economic links with Guangdong are the closest. By the end of 2004, the cumulative value of Hong Kong's realised direct investment in Guangdong was US$100 billion, accounting for 66 per cent of its total inward direct investment.

According to a survey conducted by the Federation of Hong Kong Industries in December 2003, over 11 million Chinese workers were employed either directly or indirectly on the Mainland by industrial ventures with Hong Kong interests. This was about 62 times the size of Hong Kong's own manufacturing workforce. Within this total, about 10 million Chinese workers were employed in Guangdong. Hong Kong's huge direct investment in the Mainland has contributed to the latter's industrialisation, and at the same time facilitated the rapid structural change in the Hong Kong economy.

The Mainland is likewise Hong Kong's largest source of foreign direct investment (excluding tax haven economies). By the end of 2004, the Mainland had invested a total of US$131 billion in Hong Kong, accounting for 29 per cent of the total external direct investment here. According to the Ministry of Commerce, there are over 2 400 Mainland-backed enterprises operating in Hong Kong enjoying easier access to global funding and the opportunity to extend their businesses to the overseas markets. Such investment helps boost Hong Kong's position as the regional services hub.

In tandem with the surge in cross-boundary business activities, financial links between Hong Kong and the Mainland have strengthened substantially over the past years. Comparing end-2005 with a year earlier, external liabilities of Hong Kong's authorised institutions to entities in the Mainland grew by 19 per cent to $476 billion, and their external claims on entities in the Mainland also grew by 25 per cent to $325 billion.

The Bank of China (Hong Kong) Limited is one of the largest banking groups in Hong Kong. It is also one of the note-issuing banks in Hong Kong along with the Hongkong and Shanghai Banking Corporation Limited and the Standard Chartered Bank (Hong Kong) Limited. The other state-owned commercial banks, the China Construction Bank, the Agricultural Bank of China, and the Industrial and Commercial Bank of China, were all granted banking licences to operate in Hong Kong in 1995. The HSBC Group, the Standard Chartered Bank and the Bank of East Asia meanwhile are among the best-represented foreign banks on the Mainland.

Hong Kong is also a major funding centre for Mainland enterprises. By year-end, a total of 335 Mainland enterprises were listed on Hong Kong's stock market. Among them, 37 were listed in 2005, raising equity capital of $150.8 billion. The more prominent listings in 2005 included those of China Construction Bank Corporation, China Shenhua Energy Company Limited and Bank of Communications Company Limited. All these listings have helped broaden the base of Hong Kong's stock market, and further entrench Hong Kong's position as a major fund-raising centre in the region.

The HKSAR Government and the Central People's Government reached an agreement on liberalisation measures under the third phase of CEPA (CEPA III) on October 18, 2005, in which all products of Hong Kong origin could be given tariff-free treatment by the Mainland starting from January 1, 2006. The tariff concession should give a further boost to the competitiveness of Hong Kong products on the Mainland market. By year-end, around 10 000 certificates of origin had been issued, covering exports valued at around $3.5 billion.

Within the first two years of implementation, Hong Kong's businesses saved a total of around $240 million in tariffs. There were also 23 additional liberalisation measures under CEPA III, covering 10 services sectors: legal, accounting, audio-visual, construction, distribution, banking, securities, tourism and transport sectors, and individually owned stores. These CEPA concessions give Hong Kong companies a 'first move' advantage in the Mainland market and foster better synchronisation of the chain of cross-boundary economic activities in finance, production and distribution. The improvement in efficiency and productivity should help reduce transaction costs significantly to the benefit of both the Hong Kong and Mainland economies. There are 27 services sectors benefiting from CEPA and more than 910 Hong Kong Service Supplier Certificates were issued by year-end.

With continuing reform and further liberalisation of the Mainland economy, particularly after its entry into the WTO, more foreign investment can be expected to flow into the Mainland. Hong Kong's role as a service hub for the Mainland will continue to strengthen. Hong Kong has carved its own lucrative niche — it both partners foreign enterprises seeking to enter the Mainland market and provides them with business support services. In addition, as more Mainland enterprises seek to extend their businesses outwards, Hong Kong can also help them to gain access to overseas markets.