BY TRINH NGUYEN
For decades, Hong Kong has thrived with its unique status, facilitating investment and trade between Asia and the West. Its airport, seaport, and railways link goods, services, and travelers to the Asia Pacific region for trade and commerce, with rising connectivity with mainland China. While Chinese cities are investing heavily in hard infrastructure to rival Hong Kong, what is truly irreplaceable about Hong Kong is its special status, or “one country two systems,” that puts it in a unique position compared to the tightly controlled Chinese economic and financial system that includes import duties, value added taxes, capital controls, and restrained labor mobility.Behind capital market might of Hong Kong is its unique “soft infrastructure” that China has relied on to deal with the economic shortcomings of the mainland, especially access to international capital markets. Hong Kong is an important springboard for foreign direct investment, as 64 percent of inward foreign direct investment to the mainland comes from Hong Kong and 65 percent of outward foreign direct investment was also channeled through Hong Kong between 2010 and 2018. Hong Kong has long been the largest offshore center for China and holds a special access to Chinese equity and fixed income markets through stock and bond connections. Hong Kong took up 73 percent of mainland companies’ initial public offerings overseas from 2010 to 2018.
And it is not just capital that can move freely in Hong Kong, but labor too. Both Hong Kongers and foreign residents enjoy relatively unrestricted travel due to fewer visa restrictions Hong Kong’s own government even markets itself to the international business community as the first-choice location for doing business in Asia and with mainland China. The Hong Kong Policy Act of 1992, for example, treats Hong Kong as special, autonomous region and exempts it from many tariffs imposed on China.
Thanks to this, whether it is tourism, trade, or finance, Hong Kong is punching above its weight as regional and global players take advantage of this special arrangement. For example, Hong Kong International Airport boasts to be the largest air cargo hub while the deep-water port ranks 7th busiest in the world. In tourism, Hong Kong, received 65 million of tourists in 2018 for a population of 8 million. Re-exporting of goods, too, are huge, amounting to 1.5 times Hong Kong’s gross domestic product. Beyond trade and tourism, Hong Kong is seen as a parking place for the region’s wealth given its strong property rights, rule of law and open capital account. Real estate transaction value in 2018 alone was 23 percent of the city’s gross domestic product due to strong demand and perception of excellent storage of wealth.
While rapid integration with mainland China has served businesses, ordinary Hong Kongers face increased competition from mainlanders for public goods and believe upward mobility may be limited by more competition for assets and employment opportunities with mainland Chinese. The prolonged protests that shutdown Hong Kong’s prized hard infrastructure, especially its airport, and policy makers’ ineffectiveness in de-escalating the tension indicates to investors that Hong Kong may not be the special and trusted place they initially thought.
What makes Hong Kong special is at risk and investors are now looking to diversify. This is a two-way street, limiting investor security in bringing business to Hong Kong, but also increasing scrutiny of Hong Kong based businesses seeking to expand in other markets. Australia has already begun to treat investment from Hong Kong with the same scrutiny as the rest of China. In the United States, Congress is considering the Hong Kong Human Rights and Democracy Act that would leave the city vulnerable to American sanctions.
While Hong Kong is unlikely to face American sanctions and the Chinese government still sees value in Hong Kong’s ability to access global capital markets, investors are likely to hold off on additional investments in the city due to rising doubt of Hong Kong’s future. In a recent survey of businesses, 88 percent of those without offices in Hong Kong say that the current standoff would affect their future investment decisions and 75 percent with offices there say that it would impact future investment decisions.
The bottom line is that while investment in Hong Kong may not change rapidly, continued uncertainty will erode the foundations that make Hong Kong special in the minds of global businesses. Other cities like Singapore are viable alternatives to Hong Kong for businesses seeking a foothold in Asia. But it is not just Singapore. Already, Malaysia and Thailand saw an influx of investment into luxury real estate at Hong Kong’s expense. Tourism in Thailand, too, saw a surge in July as mainland Chinese tourists stayed away from Hong Kong.
Beyond political volatility, mainland Chinese investment in ports, airports, and railways were already eroding Hong Kong’s advantages in hard infrastructure. But the pro-longed policy paralysis to resolve the difficult equation of Hong Kong being special while rapidly integrated with China, not just economically but increasingly soft infrastructure, is increasingly jeopardize investor’s faith in the sustainability of the city’s ability to remain autonomous as it assimilates with China is in deep doubt. Investors are asking when it will ultimately be subsumed into mainland China and lose its special status for businesses wishing to engage with China’s huge economy. The longer this goes on, the more investors’ fear will drive them to hedge by engaging with Hong Kong’s Asian competitors.
Trinh Nguyen is an emerging market senior economist at Natixis and a nonresident scholar in the Asia program at the Carnegie Endowment for International Peace.