COUNTRY COMPARISONS     

 

One Country, Two Systems:
A brief comparison
of the economic systems
of Hong Kong and China


by Adrian Lai, April 2002

 

 

“One country, two systems.” In 1997, that was the most frequently heard phrase in Hong Kong. That year marked the return of Hong Kong back to Chinese Sovereignty after 156 years of British colonial rule. In 1984, China had signed the Joint Declaration, a Post-Handover treaty guaranteeing Hong Kong’s way of life for 50 years with the exception of foreign and defense affairs. “One country, two systems” summarized communist China’s policy of how it would govern Hong Kong once handed over.

Today, 5 years after the Handover, Hong Kong Special Autonomous Region (SAR) remains one of the most capitalist market economies in the world. It is a thriving international financial center and one of the world’s busiest container ports. On the surface, Hong Kong continues to progress under the principle of “Hong Kong people running Hong Kong.” The official government website boasts that legal and financial systems remain within the full control of Hong Kong SAR. It also states that the HKSAR “participates on its own as a full member in international organizations and conferences,” such as the World Trade Organization (WTO) (Information Services Department). In contrast, China’s political system is Communist although its economic system is catching up. It has implemented a “Go West” strategy to accelerate embracement of Western markets. In a broad perspective, it is moving towards Hong Kong in the spectrum of economic systems. However, being under China’s shadow, Hong Kong also has the influence of being implicitly subverted by China’s political system. The application of “One country, two systems” is crucial to determining the fate of both economic systems.

Hong Kong has always identified itself with China as Hong Kong people have far-reaching ancestral ties with the motherland. However, Hong Kong’s unique colonial history combined with its global achievements has created a distinct national identity. Post 1997 Hong Kong still retains numerous colonial influences that are visible in its architecture and appearance. Many British-given street names remain unchanged and lawyers are still required to wear white wigs when practicing in court. The Mainland Chinese have traditionally perceived Hong Kong as a land of opportunity. In the late 19th century, it was a center for Chinese emigration to the U.S. In modern times, Hong Kong’s achievements have continued its reputation of success (Kestell and Meinheit). One example is the Hong Kong film industry. Stephen Teo comments, “Hong Kong cinema has a global identity in the sense that it does have a global market of its own” (Teo). Along with actors, Hong Kong’s music industry has also created pop stars that are idolized throughout Asia. These successes have contributed to shaping and marketing Hong Kong’s identity to the rest of the world.

However, prior to Hong Kong’s 156 years of British rule, Hong Kong’s identity was part of China’s. With roughly 1.3 billion people, China has the largest population in the world consisting of 56 ethnic groups. “For most of its 5000 years of history, China led the world in all facets of agriculture, crafts, and science” (Papadimos). It was only after Europe’s industrial revolution in the 19th century that China’s prominence fell behind and became secondary to Western imperialism. The change in dominating power had a huge impact on Chinese national identity. For many years, Chinese people were victimized by Western powers and that has culminated in a strong national sense of not wanting to lose out to the West. Hong Kong itself was a casualty of foreign oppression. Previously a Chinese trading port, it was forcefully ceded to the British in 1841, following China’s defeat in the first Anglo-Chinese Opium War. The War was a result of British imposition of illegal opium imports into China. After the defeat, China was forced to sign the Treaty of Nanking to repay the Opium that was destroyed. The treaty (often referred to as “The Unequal Treaty”) sealed the exchange of sovereignty of Hong Kong, and included other privileges such as granting British Nationals exemption from Chinese Laws, and opening Chinese ports to British trade. “The Treaty of Nanking set the scope and character of an unequal relationship for the ensuing century of what the Chinese would call ‘national humiliations’” (Poon).

Another turning point in China’s history was 1949. In that year, Mao Ze-Dong’s People’s Liberation Army overthrew Chiang Kai-Shek’s Nationalist Party and brought the ruling communist party into power in China. Mao made many important changes, including giving women full equality with men, and nationalizing all private property. However, China’s economical and technological progress deteriorated under his dictatorship and policies. Mao’s implementation of “The Great Leap Forward” (1958-60) caused over 30 million people to die from starvation and his Cultural Revolution (1966-76) threw the country into chaos and turmoil. An International Business Ethics web page on China discusses, “the greatest loss of the revolution is that the generation of children that grew up during this time did not receive a quality education.” This effect had long lasting repercussions that are still being felt today and has contributed to shaping China’s policies (Purcell).

After Mao’s death, his successor, Deng Xiao-Peng introduced radical economic reforms. Deng’s reforms de-emphasized Marxist policies, and instead focused on “more-rapid economic growth, the role of market forces, and foreign trade and investment from the West” (Papadimos). In its gradual transition towards a socialist market economy, China experienced rapid growth under Mao’s leadership. In 2001, China ranked seventh in the world in terms of economic capacity. China’s recent accession into the WTO in December 2001 also promises to open more opportunities and relations for continued growth.

Although operating under different systems, Hong Kong’s economy is inevitably linked to China’s. This relation is particular visible in their comparative monetary systems. Joseph Yam J.P., Chief Executive of the Hong Kong Chamber of Commerce, describes the relationship as “two currencies circulating respectively as the legal tender in two different social and economic systems” (Yam). China defines the co-existence of the two monetary systems as “mutually independent” which implies that neither system is superior or subsidiary to the other (Yam). To further elaborate the relationship, China specified that Hong Kong assets and liabilities would be treated as foreign on the Mainland, and vice versa. During the period after 1997, there were concerns about whether China would establish a fixed relationship between the RMB and the Hong Kong dollar, but Hong Kong’s currency remains pegged to the US dollar at 7.8 to 1. The Hong Kong dollar is fully convertible, while the RMB is not. However, Mr. Yam defends the current system. He says “the linked system has served Hong Kong extremely well and there is no need and no intention whatsoever for changing it”(Yam).

China seems to have every reason to support Hong Kong’s currency stability. Although Hong Kong’s population is only half a percent of the population of China’s, its money supply is 40% that of China’s. According to Mr. Yam, in terms of the asset size of the banking system, Hong Kong is 1.3 times that of China. Hong Kong also holds more than $60 billion in foreign exchange reserves, about 80% as large as China’s. However, the Basic Law states that the exchange fund shall be completely managed and controlled by the government of Hong Kong. In addition, the Basic Law stipulates that Hong Kong’s financial revenues shall be used exclusively for its own purposes, and that China will not levy taxes in Hong Kong. Mr. Chen Yuan, deputy governor of the People’s Bank of China (China’s monetary authority), gives his assurance that the “triple safeguards are evidence that China does not have its eyes on siphoning off the resources of Hong Kong” (Yuan).

Because of Hong Kong and China’s close economic relations, their “mutually exclusive” monetary authorities need to establish close cooperation to monitor financial transactions between the two economies. “Hong Kong is the largest trade and investment partner of China,” says Mr. Yam. However, being distinct, the monetary authorities of the two economies are characteristically different. Under the basic law, the Hong Kong Monetary Authority (HKMA) maintains internationally recognized regulatory standards to supervise all financial institutions in Hong Kong, including those from the Mainland. In comparison, prior to its WTO accession, China struggled to reform and liberalize its banking system. Part of the agreement reached between China and the US on China’s WTO accession included “a phased opening up program of China’s banking market to foreign banks” (Standard Chartered). This meant that Chinese banks would face intense foreign competition, encouraging China’s monetary authority to move towards international standards.

China’s impeding accession to the WTO meant increased pressure to quicken the pace of reform. Before that, the banking sector had been undergoing major reform due to China’s gradual development to a more market-orientated economy. A 1999 Standard Chartered report states, “China’s rapid economic progress in the past two decades has made banking reform an increasingly urgent job for the country.” The situation in the late 1990s did not look good. In 1999, 70% of the banking sectors deposits and loans were accounted by four State-owned commercial banks. Being State-owned, they were subject to the government’s industrial policy and were inefficient. “In 1998, all the four state banks had their return-on-assets (ROA) and return-on-equity (ROE) below 0.1% and 1.5%, based on reported figures” (Standard Chartered). At the time, some of the most serious inadequacies of the banking system included excessive lending to loss-making enterprises, and a large buildup of non-performing loans. This inefficient allocation of capital threatened the country’s financial stability and economic performance.

China adopted a series of policy initiatives to reform its banking system. Among these reforms was the issue of 270 billion RMB in Treasury bonds to re-capitalize the four State banks. Another method to encourage commercialization was to extend the banks’ customer base from traditional State-Owned Enterprises (SOEs) to non-state enterprises. China also set up four special Asset Management Companies (AMCs), “similar to the US Resolution Trust Corp, to take over bad loans from banks and repackage them for sale to investors” (IBJ Asia). However, Chi Lo questions the effectiveness of the AMCs. In a September 6, 2000 article, he argues that the reform process will take longer than expected because the “AMCs cannot function properly due to an inadequate legal framework and questionable incentives”(Lo). This means that prospective buyers will not want to buy the repackaged assets from the AMCs if they are unsure that the courts will secure their purchases. Chi Lo also argues that SOEs will be unlikely to improve management, and banks will be unwilling to recover their non-performing loans, if they are certain that the AMCs will absorb their losses.

China has much to learn from Hong Kong, whose banking system is amongst the most efficient in the world. Hong Kong’s banking system has contributed largely to making Hong Kong the 9th largest international banking sector and 9th largest foreign exchange center in the world with a daily turnover of US $80 billion. Unlike China, Hong Kong’s banking sector is highly external-orientated. Hong Kong’s trade and development council quotes, “Hong Kong is the second largest international banking center in Asia after Japan in terms of external assets. The banking system’s external assets amounted to US$ 450 billion as at end-2000” (Hong Kong Trade Development Council: Profiles). In comparison, China’s net external assets were “US$ 142.6 billion by the end of June 1997” (Susumu).

Still, China’s economy continues to develop at a rapid rate (7.3%), leading to the comparison between Hong Kong and Shanghai--the country’s main financial centers (China Online). Shanghai’s population stands at 14 million people. The city is enjoying a phenomenal growth spurt, heading towards its 11th year in double-digit GDP growth. In 2001, the growth rate was 10.2 % (China Daily). Development in Shanghai is being carried out on a massive scale; Richard Hannah estimates that, “25 percent of the construction cranes in the world are in Shanghai” (Hannah).

Shanghai’s industry is structured into three categories, primary, secondary and tertiary. The city has focused its priorities on restructuring the tertiary industry, which consists of finance and insurance; commerce; transportation; post and telecommunications; and real estate and information technology. The fastest development is being seen in the finance and insurance sector with its proportion of GDP becoming the largest of all the tertiary sectors (Official Website of Shanghai Municipality: Internal Structures). The service sector, now accounts for about half of Shanghai’s GDP. Manufacturing accounts for 28% of GDP and agriculture for 1% (Asia Incorporated).

The city is rapidly establishing itself as an economic powerhouse. Shanghai is the home to China’s foremost stock exchange, with 570 listed stocks. With only 1/100 of China’s population, the city contributed 1/8 of national financial revenue. Shanghai’s municipal government states, “During the Ninth Five-Year Plan period in 1995-99, Shanghai’s total financial revenue hit 623.41 billion Yuan, the largest growth since 1978 and an annual increase of 20.1%” (Official Website of Shanghai Municipality: Financial Revenue). Foreign investment has played a large role in Shanghai’s development, with the number of new foreign investment projects in 2000 rising by more than 23 percent. By the end of 1999, Shanghai’s accumulative paid-in foreign capital was 27.7 billion (USD) (Shanghai Foreign Investment Commission). Further visible evidence of Shanghai’s rising financial influence is the undergoing construction of the Shanghai World Financial center. When completed, the 95-story building will stand as the tallest in the world.

In terms of ownership, Shanghai is increasingly becoming privatized. According to the Shanghai Municipal Administration for Industry and Commerce, “the city had 139,301 private companies at the end of October (2000), up 250 percent from the end of 1995” (Peoples Daily). Although the structure of private ownership has diversified, the public-owned economic sector maintains its dominating position while co-existing with the various other sectors. “In 1998, the increased value generated by the public-owned sector reached 283.782 billion yuan, 76.9% of the city’s GDP” (Shanghai Jin Wei Commercial Affairs Developing Co. Ltd.).

In contrast, Hong Kong has virtually no state-owned enterprises. Hong Kong’s economy is one of the freest in the world. “Hong Kong operates a free enterprise, free trade “laissez-faire” economic system with minimal government interference in all sections of the economy”(Johnson, Stokes, and Master). The Basic Law also guarantees many fundamental rights, including private ownership of property, and freedom of speech. Hong Kong’s average annual real growth rate of GDP was 4.4 percent during the last decade. This translates to about half the rate of Shanghai’s GDP growth; However, Hong Kong is already firmly established as an international trading and financial center. It is ranked as the 8th most competitive economy of the world in 2000 (World Economic Forum’s Global Competitiveness Report, September 2000), and the 9th largest trading entity in goods in the world in 2000 (World Trade Organization, May 2001).

The manufacturing industry; trade, distribution; restaurants and hotels; and banking, insurance and real estate, are the most important sectors in Hong Kong, producing about one fourth of total GDP respectively. Traditionally, Hong Kong’s biggest asset was its manufacturing sector with textiles, electronics and cheap goods bearing the famous “Made in Hong Kong” label. However, Hong Kong’s manufacturing base is now concentrated in Southern China, with “42,000 enterprises in the province having Hong Kong participation and 4,000,000 workers (nine times larger than the territory’s own manufacturing workforce) directly or indirectly employed by Hong Kong companies” (An Anarchist FAQ). The opening up of China meant greater access to cheap labor markets and encouraged Hong Kong’s economic structure to shift from its traditional manufacturing focus to a more service-orientated economy. Hong Kong’s “service industries, including import and export trade, employ more than 75% of Hong Kong’s workforce and make up nearly 80% of its GDP” (Hongkongnet.net)

Hong Kong’s economic achievements have largely been attributed to its transition to a service dominant economy. Trade, especially re-exports, has been an important contributing factor. “In 1997, re-exports worth HK$1,244.5 billion passed through the territory, compared to domestic exports in the same period, of HK$72.2 billion.” (Hongkongnet.net) Being one of the world’s most accessible markets has definitely assisted in boosting trade in Hong Kong.

The importance of service in Hong Kong can also be seen in the financial perspective. All banks in Hong Kong are independent of the government, and the banking sector includes representatives of 79 of the world’s 100 largest banks. Additionally, Hong Kong’s stock market is the 2nd largest in Asia, in terms of capitalization. “At the end of September 2001, Hong Kong’s stock market capitalization was HK$3,420 billion (US$438 billion)”(Hong Kong SAR of the People’s Republic of China). That figure is around four times the capitalization of the Shanghai and Shenzhen stock markets combined.

Hong Kong’s success as an international financial center has largely been attributed to the free movements of goods and capital. There are no restrictions on foreign capital and investment (except in the media sector), or the amount of money that can be brought out of or into Hong Kong. Besides assisting trade, Hong Kong’s policies have also encouraged foreign investment. The economist intelligence unit reported that, “in 2000 alone, 126.8 billion US dollars was invested in the region led by a wave of merger and acquisition activity” (BizAsia News).

Because of its international exposure and experience, Hong Kong has the advantage over Shanghai. However, the view of the Chinese government is that “Hong Kong and Shanghai will after 1997 become two complementary and mutually reinforcing financial that will each develop its own characteristics under one sovereign state” (Yam). Before this happens, China’s market reforms must catch up with Hong Kong’s free market. Arguably the most significant factor preventing Shanghai from becoming a truly international financial center is the regulations on the free flow of international capital in and out of China (Hong Kong Trade Development Council: China’s WTO Accession). To achieve this, China’s reforms must include lifting foreign exchange control and making the RMB freely convertible under the capital account. China’s recent accession into the WTO will have substantial implications on Hong Kong. It is estimated that 40% of Hong Kong’s total re-exports are made up of China’s imports and exports though Hong Kong (Hong Kong Trade Development Council: China’s WTO Accession). Hong Kong’s role will be affected since the opening of the mainland market means that China’s imports and exports will be able to enter mainland ports directly instead of through Hong Kong. However, Hong Kong’s role as a financial intermediary for China will be strengthened by China’s WTO accession. “Hong Kong has always been a major source of foreign funds for Chinese enterprises” (Hong Kong Trade Development Council: China’s WTO Accession). The opening of China’s financial market not only means that Hong Kong will be able to have greater financial participation in the mainland, but also that foreign companies, attracted to China’s new economy, will continue injecting capital into Hong Kong.

It is inevitable that Hong Kong’s relations to China will become more integrated in the next 50 years. There is still great disparity between the two economic systems. Hong Kong is ranked first in the Heritage Foundation’s 2002 index of economic freedom while China’s overall rank is 121 (The Heritage Foundation). However, China’s formula of introducing market-orientated policies while holding intact its socialist political structure seems to be moving towards convergence with Hong Kong. With the Basic Law’s 50 years guarantee of Hong Kong’s capitalistic economic structure, the direction that China’s political system takes in the meantime will have great effect in determining Hong Kong’s future. The optimistic view is that Hong Kong’s influence on political and economic development in China will have a greater long-term effect than China’s increasing political influence in Hong Kong. However, when Anson Chan, Hong Kong’s chief secretary retired in 2001, speculators attributed the move to her dissatisfaction with Tung Chee Wah’s (Hong Kong SAR’s first governor appointed by China) pro-Beijing values. Other’s have cited Beijing’s criticism of Hong Kong’s court of appeals ruling on the right of abode of Mainland children of Hong Kong residents as an example that politically, Hong Kong is run as “one country” while economically, it is “two systems.” 50 years is not a long time in the rise and fall of modern cities. The formula of “One country, two systems,” and how it is applied, has enormous implications for the economic systems of both Hong Kong and China.

references

Works Cited

An Anarchist FAQ. Doesn’t Hong Kong show the potentials of Free Market Capitalism? An Anarchist FAQ. 19 April. 2002 <http://www.geocities.com/CapitolHill/1931/secC12.html> Asia Incorporated. Shanghai Guide. 24 August. 2001. Asia Incorporated. 19 April. 2002 <http://www.asia-inc.com/img/Shanghai_map.pdf.> BizAsia News. Foreign Direct Investment in Asia to Increase. 22 February. 2001. BizAsia.com. 19 April. 2002 <http://www.bizasia.com/gen/articles/stand_art.htm?ac=I3DPN-W> China Daily. Shanghai Mayor: GDP to Rise. 23 February. 2002. China Internet Information Center. 19 April. 2002 <http://www.china.org.cn/english/BAT/27431.htm> China Online. China confirms 7.3% GDP Growth. 28 February. 2002. Yahoo! Inc. 19 April. 2002 <http://sg.biz.yahoo.com/020227/46/2k0mx.html> Hannah, Richard. Shanghai Communique. August. 1998. The Economic Educator. 19 April. 2002 <http://www.mtsu.edu/~ceconed/Aug98.htm> Hongkongnet.net. Economy. Must National Communications Ltd. Hongkongnet.net. 19 April.2002 <http://www.hg.org/guide-hongkong.html> Hong Kong SAR of the People’s Republic of China. Achievements of Hong Kong in the World Economy. November. 2001. Hong Kong SAR of the People’s Republic of China. 19 April. 2002 <http://www.info.gov.hk/hkbi/enghkbi/4/4-1a.htm> Hong Kong Trade Development Council. China’s WTO Accession: Implications for Hong Kong as an International Business Center. September. 2001. Hong Kong Trade Development Council. 19 April. 2002. <http://www.tdctrade.com/econforum/tdc/010901.htm> Hong Kong Trade Development Council. Profiles of Hong Kong Major Service Industries: Banking. 16 August. 2001. Hong Kong Trade Development Council. 19 April. 2002 http://www.tdctrade.com/main/si/spbank.htm IBJ Asia. China’s Banking Reform. December 1998. Mizuho Securities. 19 April. 2002 <http://www.mizuho-sc.com/english/ebond
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/chen/speech_2100996b.htm

 

 

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