The Impact Of Economic Integration Commerce Essay

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The author of the "famous" article "Death of Hong Kong" in 1995 predicted a dire future for Hong Kong after the handover in 1997. Hong Kong is NOT over unlike what the article suggested. However, one thing is undeniable - the future of Hong Kong is tied to China's. The article attempts to assess the impact of economic integration between Hong Kong and China since 1997. The main argument of the essay is the change of HKSAR government's approach from local-advantage view to resource-flow view showing a more positive attitude towards economic integration since 2003. Next, for the impact of the integration on Hong Kong, economically speaking, goods and services as well as different factors of production are attracted from the Mainland. Politically speaking, it shows how the government's policies have been inclined towards the business sector. Socially, the influx of capital has put enormous pressure on the property market in HK. On the other way round, it shows how the Mainland benefits from the integration because of the asymmetric credibility between the two places. It concludes that economic integration is not a "cure-all" for Hong Kong economy but to develop more high-valued activities to keep its location and quality advantages over the Mainland.

Table of Contents


One may recall that a cover story of Fortune magazine titled "The death of Hong Kong in 1995 predicted the gloomy future of Hong Kong after 1997: Hong Kong's role as a vibrant international hub would be diminished because it would become a captive colony of Beijing governed by a regime filled with corruption and political connections rather than the even-handed rule of law. (Kraar, 1995)

Time, the sister magazine of Fortune, admitted their misperceptions about the death of Hong Kong by publishing a cover story titled "Sunshine with clouds" twelve years after, in 2007,which is also the tenth anniversary of the Hong Kong handover to China. (Abdoolcarim, 2007)

The verdict about the future of Hong Kong was wrong but still the road for the city has never been smooth in the post-colonial period filled with ups and downs. In the first six-year rule of HKSAR, the city already suffered from two full-scale economic recessions and one near-recession. (Sung, 2007)

Triggered by the Asian Financial Crisis, the city went through five quarters of negative economic growth since late 1997. Followed by the economic recovery fuelled with tech bubble in 1999-2000, the city suffered a second recession from mid-2001 - 2002 due to the burst of the bubble as well as the "911" terrorist attack. (Sung, 2007)

The unprecedented SARS outbreak in 2003 once again hit the recovering economy since the second half of 2002. Fortunately for the city, the episode was brief thanks to the weak U.S. dollar and PRC's economic stimulus package. Since then, the Hong Kong's economy has been growing rapidly and at the end of 2006 Hong Kong's GDP per captia reached back to the level in 1997. (Sung, 2007) It seems to paint a rosy picture for prospects of the city. Not more than 3 years, the city has faced another challenge triggered by the global financial crisis originated in U.S.

In the "sequel" to the "death of Hong Kong", one thing the article pointed out is undeniable: Hong Kong's future is closely linked with China's. (Abdoolcarim, 2007) At the same time, it should also be reminded that the economic ties between Hong Kong and China have long been established.

From 1841 to early 1950s, Hong Kong played the role as an entrepot for handling trade with mainland China. In the aftermath of WWII, Hong Kong's economy was severely affected by the embargo on China placed by United Nations. (Yeung & Shen, 2007) But still, during the time, a large number of refugees from mainland China brought the capital to Hong Kong which benefited the industrialization within the city.

Since the opening of China in 1978, a spatial pattern of labour division called "front shop, back factory" has been developed. (Sit, 1989) With the improvement of infrastructure, services including public finance, medical, housing services and most importantly the sufficient labour force at reasonable wages by the local governments of the Pearl River Delta, the region have become the production site or "back factory" for traditional Hong Kong manufacture. On the other hand, Hong Kong has played a role as "front shop" by focusing on the higher end of manufacturing activities including marketing, design, management and technical supervision. (Sit & Yang, 1997) (See Appendix A for the diagram of the model)

The links between Hong Kong and mainland have never been faltered and set to continue in the post-colonial period. This article attempts to assess the impact of economic integration between the Hong Kong and China since 1997. It is organized as follow: brief conceptual issues about the economic integration will be explained in the first section. The next section will be dealing with the overview of economic integration between the two places in particular how the government changed its approach from "Local-advantage view" to "Resource-flow view." In the third section, the impact of integration on Hong Kong will be discussed which shows how the policies aim to attract different factors of production as well as goods and services back to Hong Kong. Also, the fourth section deals with how the asymmetric credibility benefits the Mainland. Finally, it should be noticed that it is important to develop more value-added industries to keep Hong Kong competitive and prosperous.

Conceptual Issues of Economic Integration

Used in a static sense, 'economic integration' represents a situation in which the national components of a larger economy are no longer separated by economic frontiers but function together as an entity. Used in a dynamic sense it indicates the gradual elimination of economic frontiers among member states (that is to say, the abolition of national discrimination), with the formerly separate national economic entities gradually merging into a larger whole. (Molle, 2006, p.4)

Molle (2006) stated that there are two purposes of economic integration: increasing economic welfare and reducing conflicts. There are different stages of integration which argued that Trade infrastructure developments and FTAs form the first stages come first and then evolution through customs unions, a common market, economic union and finally, political union. (Czinkota et al., 2005)

Overview of the economic integration between Hong Kong and China

Unquestionably, Hong Kong has a close economic relationship with Mainland China which can be traced back to the earliest years of British colonization. But only the Open Door policy in 1978 has led to a more rapid integration between the two places, as explained in the previous section. (Sung, 1995)

Tsang (2007) suggested that there are two contesting schools of thought about the Hong Kong economic development strategy in the post-colonial period: "Local Advantage View" &"Resource-flow view." In the early days of the handover, the local advantage view prevailed which the central idea of the view was to develop a coherent economic entity but not integrating with the Mainland. However, as mentioned in the previous sections, amidst of the huge economic downturn, the resource flow view has gained the upper hand in the economic strategy since 2003. As implied by the name, the view refers to the flow of goods, services and also the factors of production (capital, labour, etc.) In the following overview of the economic integration in post 1997, we have witnessed how the local advantage view was replaced by the resource-flow view.

Under the "one country, two systems" concept, although Hong Kong is part of China, it has total autonomy in terms of economic policy-making. (Cavoli & Rajan, 2007) In the past 2 to 3 years after the handover, the HKSAR government did not play an active role in promoting economic cooperation with the mainland China but largely followed the "non-interventionist" mode and focused on maintaining its status as an international finance, trade and services centre. (Cheung, 2010)

However, faced with the economic downturn but at the same time China's entry to World Trade Organization (WTO), the HKSAR government has since than played a more provocative role in enhancing economic cooperation between Hong Kong and the mainland. (Cheung, 2010)

In 2002, the government finally set up the first Economic and Trade Office in the Guangzhou for enhancing the economic and trade liaison with the five provinces located in the southern part of China as well as giving support to Hong Kong enterprise. (HKSAR Economic and Trade Office in Guangdong, 2009) Later two more offices have bee set up in Chengdu, Shanghai.

When Hong Kong suffered from the catastrophic SARS epidemic in 2003 and amidst of the huge economic difficulties, a first ever trade agreement Closer Economic Partnership Agreement (CEPA) was concluded between the Mainland and Hong Kong on 29 June 2003. The agreement covers 3 broad areas: trade in goods, trade in services and trade in investment and facilitation. Furthermore, it is not a single agreement but adopts a building-block approach which the two sides aim to introduce further liberalisation measures at different stages. (HKSAR Trade and Industry Department, 2008)

In addition to that, a few years before the implementation of CEPA, a discussion was commenced on cooperation framework between the 11 governments (Hong Kong and Macau) and nine provinces in the mainland (Fujian, Guangxi, Guandong, Hunan, Hainan, Jiangxi, Guizhou, Sichan, Yunnan). (Pollard, 2005)

Finally, the Pan-PRD Regional Co-operation Framework Agreement was signed when the first PPRD Regional Cooperation and Development Forum was held in Hong Kong in 2004. Since then, Hong Kong has also taken measures to explore new co-operation opportunities and capitalise on its unique advantages in the region, such as promoting the implementation of CEPA, making plans for major infrastructure projects, such as the Hong Kong-Zhuhai-Macao Bridge, and also different visits and research projects. (HKSAR goverment, 2006)

Despite the close economic interactions between the Mainland and Hong Kong, there is no similar form of economic integration appeared as mentioned in the above section. This is partly because Hong Kong is long been a free port, and partly because the political division between Hong Kong and China before 1997. Even in the early days of post-colonial era, the economic integration at the governmental levels was not active. Ironically, the economic integration has been facilitated since 2003 when the HKSAR government faced the enormous difficulties in the aftermath of SARS epidemic. When applying the economic integration concepts, The PPRD development can therefore be mapped to the first evolutionary stage whereas CEPA is more advanced in terms of evolution. (Pollard, 2005)

Impact of economic integration on Hong Kong

CEPA as a life-saving straw

As mentioned earlier, Hong Kong was severely hit by the SARS epidemic in 2003. Then the CEPA was then introduced by the Mainland in order to boost the economy and strengthen the confidence of people in Hong Kong. Among all the arrangements, the so called "Individual Visit Scheme" (IVS) benefits Hong Kong most particularly the tourism industry. Traced back to November 1983, a so called "The Hong Kong tour" was arranged which the mainlanders were allowed to visit their relative in Hong Kong under a quota system. After 1997, the HKSAR government and Guangdong government agreed to relax the quota system. (Yang, 2006) Under IVS, the residents of a number of cities on Mainland are allowed to visit Hong Kong individually two times within a year and stay each time in Hong Kong up to 7 days. (HKSAR Trade and Industry Department, 2006)

Since the adoption of the IVS, both the number of Mainland visitors and tourism receipts rose visibly. The total number of arrivals in 2006 was twice as many as the number in 2002. (HKSAR Trade and Industry Department, 2006) If only comparing the number of Mainland visitors through the IVS, the result was even more astonishing given there was a 10 times increase since the start of the scheme. (See Appendix B) Not surprisingly, there has been also a steady increase in tourist spending since the adoption of the scheme. (See Appendix C) The IVS has benefited most the retail sector which the IVS-induced employment in this sector rose 64% when compared to 2004. All in all, it is estimated that the additional visitor spending has generated employment for more than 25000 persons in 2006. (HKSAR Trade and Industry Department, 2006)

Another beneficiary of CEPA is the service industries. CEPA granted preferential treatment for Hong Kong's 18 services industries at the initial stage. (More was added after several CEPA supplementary agreements) Apart from granting the entry to China to companies offering the services mentioned in the agreements, smaller companies will receive help as the thresholds of entry to mainland's service sectors are lowered as well. For instance, the threshold of opening a branch in mainland China by foreign banks is lowered from US$20 million to US$6 million of the assets. More importantly, unlike the lifting of the restriction on foreign companies under WTO agreement, the Hong Kong companies can have immediate entry to the China's market. (Chiu, 2006) The impact on the service industries can be reflected by the issuance of Hong Kong Service Supplier (HKSS) certificates. Only the bearers of the HKSS certificates have the rights to enjoy the preferential treatment under CEPA. From only 300 something certificates were issued at the start of the scheme, now more than 1700 certificates have issued in 2007. For the companies themselves, CEPA has generated HK$9.1 billion worth of services receipts for companies in the 22 services industry groups which is equivalent to 4.4% of these companies' overall services receipts from the Mainland market during the same period. It should be noted that the rate of increase in service receipts duet to CEPA is remarkable. The value of exports in 2006 was 2.6 times than that in 2004. A further 28% increase is expected in 2007 and beyond. (HKSAR Trade and Industry Department, 2006)

The liberalisation measures under CEPA also extend to the financial sector.

Banks in Hong Kong were allowed to conduct Renminbi banking business since early 2004. On the other hand, the issuance of Renminbi bonds was introduced first time in 2007 by one of the three policy banks in the Mainland-the China Development Bank. More than that, the QDII ("Qualified Domestic Institutional Investors") Scheme was launched in April 2006, paving the way tor Chinese portfolio investments in the securities markets in Hong Kong. (Tsang, 2007)

CEPA to turn the way back

Yang (2006) has argued that under the "One Country, Two systems" framework, the economic complementary between two places has been provided and ensured. Thus, since the 1990s, the "front shop, back factory model" has been further expanded which the low-end value-added services including retiling, recreation and leisure, accounting, data processing in the front shop are all relocated from Hong Kong to the back shop. According to the Federation of Hong Kong Industries (2003), half of the surveyed companies expressed their intentions to keep the "front-shop" activities including financial mangment, sales and marketing, IT technology, management, R&D storage in the next 2-3 years. However, it should be reminded that more than half of the companies indicated that they would increase all these activities in Guangdong. Worryingly, in terms of procurement of materials, storage and transportation, and production activities, 42%, 37%, and 35% of surveyed companies intended to decrease the level of the three activities respectively. It further shows that particularly in the early days of handover, there was a trend of modifying the "front shop, back factory" model which more front shop activities would be relocated.

From the late 1970s, the economic integration between the Mainland and Hong Kong has been taken place in an inward direction which the Hong Kong companies "go into" mainland China and develop their business. (Obviously the famous model mentioned in this article) Hong Kong has long been the largest investor in mainland China (no doubt redirecting other countries' foreign investment to China). It accounted 37% of the total FDI value in 2008, ahead of other free ports including Virgin Islands, Barbados, Mauritius, Cayman Islands and Western Samoa by 15%. (See Appendix E) Certainly, the manufacturing sector since then plays a minimal role in Hong Kong's economy which accounts only 2.5% of GDP in 2008. (HKSAR Census and Statistics Department, 2009a)

However, Kwan (2007) argued that CEPA has served as an impetus to flow people, capital and goods from the Mainland to Hong Kong. For the flow of people, there has been a sharp increase in the number of visitors to Hong Kong thanks to the relaxation of issuance of visa to Hong Kong under the CEPA agreement as mentioned in the prevoius section.

Furthermore, in terms of the flow of capital, Hong Kong's securities and futures companies and professionals can be granted easier assess to the mainland market under CEPA framework. For the Hong Kong professionals, they are exempted from the examinations on professional knowledge but only required to undertake training and examinations regarding the mainland laws and regulations if they want to obtain the securities and futures industry qualifications of the mainland. (HKSAR Trade and Industry Department, 2003)

Hong Kong then becomes the primary offshore financial centre for the Mainland companies. In recent years, a series of initial public offering (IPOs) have been taken place in Hong Kong. The most astonishing one should be Industrial & Commercial Bank of China (ICBC) raised a record US21.9 billion in 2006. (China Daily, 2006) More than that, the inward of direct investment from mainland China has been increased steadily since 2004 except a upward surge in 2007. When comparing the inward direct investment in 2004 and 2008, it has recorded a 126% increase from HK$1020 billion to HK$2311 billion. (HKSAR Census and Statistical Department, 2009b)

In terms of trade in goods, under CEPA framework, zero-tariff is applied for all the goods of Hong Kong origin. It also enhances some manufacturers particularly the high-value industries to "move back" some of the activities from the Mainland China. They could enjoy the better intellectual rights protection in Hong Kong and the more preferred brand name of 'Made in Hong Kong' which can offset the rising costs of wages in Hong Kong. (Chiu, 2006)

Although it is very difficult to determine to quantify how many activities are moving back to Hong Kong since the adoption of zero-tariff, the issuance of CEPA certificates of origin can reflect the "enhancement" of the local activities. As at end April 2007, more than 22000 applications of the CEPA certificates of origin were approved and the total export value generated was more than HK$8 billion. (HKSAR Trade and Industry Department, 2006) It should also be noted that the relative share of products with CEPA certificate of origin to domestic exports to the Mainland has been increasing steadily. (See Appendix F)

Capital Investment Entrant Scheme (CIES)

CIES is another "product" originated in 2003. The objective of the scheme is to enhance the entry for residence by persons making capital investment in Hong Kong which would not be engaged in the running of any business here. Entrants are free to make their choices of investments amongst permissible assets which do not require any involvement in establishing or joining a business. (HKSAR Immigration Department, 2008a) It should be understood that this scheme does not only target the people from the Mainland. Citizens from overwhelming majority of countries in the world (only with the exception of a handful of countries including Afghanistan, Albania, Cuba and Democratic People's Republic of Korea) are eligible for the scheme. (HKSAR Immigration Department, 2008b)

When considering different requirements of the scheme, the most debatable one is that applicants need to have no less than HK$6.5 million permissible net asset including either or both real estates and financial assets (equities, debt securities, certificate deposits) (HKSAR Immigration Department, 2008c)

Though the scheme is applicable to most of the countries in the world, the "Mainlander" accounted for the largest share of total number of applicants. As at 31 March, 2010, 77% of the applicants are the Chinese nationals. If including the applicants from Macau and Taiwan, the figure is even up to 83%. (See Appendix D)

It is unquestionably the scheme attracts capital from the Mainland which is the main purpose of the scheme capital investment under CIES. The scheme has brought a total of HK$40.1 billion capital investment which no doubt benefits different related industries including finance, property agent, building maintenance and decoration industry. (HKSAR Legislative Council, 2010)

Kwan (2007) argued that Hong Kong has evolved from a "gateway to China" into "a business platform serving China". The flow of capital now is in a two-way direction. In the post-colonial period, particularly after 2003, we have witnessed an inflow of people or visitors, goods, and capital to Hong Kong under the CEPA and CIES frameworks.

Political Impact - The change of "view" but tendency towards the business sector

In the overview section, we have witnessed a change of the local advantage to resource-flow view since 2003. However, it should also be noted that how the HKSAR government's policy implementation has been also much affected by the business sector since the economic integration.

In the early days of handover, the Hong Kong SAR government showed a negative attitude towards both cross-boundary integration and Free Trade Agreement (FTA) issues. (Takeuchi, 2006)

For the cross-boundary integration, although after the opening of China in the late 1970s, there was a mutually complementary relationship between HK and Shenzhen and Guangdong Province. However, the improvement of transportation and logistics infrastructure in Guangdong Province could affect the role of HK as a regional hub. More than that, the two cities aim to attract hi-tech human resources as well as foreign direct investment. (Cheng & Ngok, 1999)

Same for FTA, the Hong Kong SAR government did not show a provocative attitude towards any regional trade agreement, including proposals for an FTA. During that time, the progress on negotiations for the formation of FTAs with New Zealand and Japan both ended up in failure.

However, with the poor level of achievement including aggressive housing policy, mismanagement of influenza crisis and SARS epidemic of the first regime of HKSAR under Tung Chee Wah and the businessmen dominated election committee finally paved the way for the conclusion of the RTAs. The business community made them to adopt a positive attitude towards the CEPA. (Takeuchi, 2006) Since then, the HKSAR government policy not only adopts the resource-flow view but also becomes more and more supportive of business community.

Social Impact -- Influx of Capital - A two-edged sword

As mentioned earlier, the influx of capital brought by CIES have benefited the property and stock market and their related industries. However, the scheme has led to a surge of rising property price which ultimately affect the living of Hong Kong citizens.

Before discussing the impact on the property market, a brief comparative analysis between the CIES and other similar schemes introduced in different countries is needed. CIES indeed is not an innovative scheme but countries including Australia, Canada, Singapore, and the United Kingdom have already introduced similar types of schemes. When comparing CIES with other countries' schemes, the major difference is that real estates is not considered as a permissible asset in all other schemes except Singapore's scheme. However, even in the Singapore's scheme, investment amount for the residential property can only be up to 50% of the total investment. (See Appendix G)

When considering the CIES, a total of HK$12 billion has been put in the property market in a total of HK$41 billion investment received since 2003. It has accounted nearly 30% of the total investment received which is the second-highest among all the permissible asset classes. (HKSAR Legislative Council, 2010)

To make it worse, if looking at the breakdown analysis of CISE, there has been a huge increase in the amount of investment spending into the property market since 2008. But only in 2008 and 2009, HK8.8 billion was spent into the property which is 75% of the total amount of investment spent into the property market since the commencement of the scheme. It truly reflects the influx of capital into the property market recently. (HKSAR Legislative Council, 2010)

According to the Centaline Property Agency Limited, mainland buyers accounted for 18.1% of buyers of flats valuing more than HK$1.2 billion in 2008. (å¤å…¬å ± [Taikungpao], 2009) It seems that it is a separate issue between the top-end flats and the small medium units market. But according to the report done by Rating and Valuation Department (2010), the number of small/medium units and large units completed in 2009 hit the lowest and highest points respectively since 2005 (See Appendix H) which truly reflects the change of strategy of the property developers and thus put enormous pressure on the small/medium property market. In the same report, the price indices (100=1999) for the small/medium market increased from 106.8 to 130.7 from 2008-2009 reflecting the inequilibrium of demand and supply in the market.

Impact of integration on China

Much of the discussion in the essay touches the impact of integration on Hong Kong. The reason is simple: the so called economic integration after 2003 indeed most involves how the Mainland China has allowed "exports" such as capital and vistors to Hong Kong in order to boost the economy.

But as Tsang (2007) introduced the concept so called "crediblity asymmetry" between the Mainland and Hong Kong, the city still maintains the quality advantage over China given some soft issues including quality management, legal foundation and professional knowledge in accounting, law. Thus, by grating the preferential assess to those professionals in Hong Kong, then on one hand, the Mainland companies can enjoy the high standard of service industries' service in order to link them to the international market, the domestic service industry can benefit from the Hong Kong's service industries through the mutual recognition of qualifications and conduct.

Conclusion - Time for change

2003 was a crucial point for economic integration between Hong Kong and China which the resource-flow views completely replaced the location-advantage view. The first ever FTA - CEPA and the Capital Investment Entrant Scheme (CISE) have tried to attract different factors of production, goods, services from the Mainland to Hong Kong. Particularly in the tourism industry, and stock market, large number of tourists and huge amount of capital has flown from the Mainland to Hong Kong. Politically speaking, the government has played a more active role in seeking economic integration with the Mainland and more importantly its policies are more and more supportive of business community. Socially speaking, the property market in Hong Kong has been severely affected by the influx of the capital. The Property developers are focusing more on high-end market in order to meet the demand from the Mainlanders thus ultimately result the inequilibrium of the demand in small/medium market.

Bearing this in mind, Tsang (2007) argued that facilitating the resources flow between the Mainland and Hong Kong is not enough to keep Hong Kong competitive in the future. Although the economic integration has gradually removed the virtual economic "boundaries" between HKSAR and the Mainland, it could result in both net inflow and outflow of resources. Given a opener China in the foreseeable future, the locational and quality advantages will be threatened. Thus, it is of utmost importance of Hong Kong to develop high-valued industries instead of relying totally on the traditional pillars such as financial services, trading and logistics and tourism.