EF3461 The Economies of Mainland China and Hong Kong

1. EF3461The Economies of Mainland China and Hong Kong Tutorial 2Hong Kong’s economy City University of Hong Kong Dr. Isabel Yan

2. Discussion Question Discuss the features of Hong Kong’s economy during the transition period (1984-1997) and the post-1997 period based on the following article: • Li, Kui Wai, Chapter 2: Economic Performance in Transition Years

3. Key events that marked the beginning and the end of the transition period: 1984 : Conclusion of the Sino-British negotiation which laid down the constitutional framework for the HK Special Administrative Region (HKSAR). Under this framework, HKSAR is to remain autonomous for 50 years after July 1, 1997. 1997 July : HK’s sovereignty was returned to the Mainland China Aug : Asian financial crisis

4. 1984-1997 • Short-term investment behavior Investors preferred short term investment because they considered July 1997 as a terminal date before which the return of the investment must be realized. Also, investors tend to engage in investments that can be easily be liquidated in short notice. Speculative Activities Speculative activities in stocks and real estates are typical examples of short-term investment behavior. Wealth effect The rise in demandfor private property drove up the price of stocks and properties. The asset appreciation in both stocks and property market reinforced each other. Besides, wealth expanded as asset prices appreciated. Wage-inflation spiral Rise in aggregate demand led to higher inflation and wages in both private and public sectors. The inflation in the service sector was higher than that of the manufacturing sector because the manufacturing sector was more competitive due to the close substitutes from import. On the contrary, the monopolistic nature of the service sector allows the service sector to increase prices more rapidly.

5. Structural imbalance: 1) Shrinkage of the manufacturing sector and expansion of the service sector The shrinkage of the manufacturing sector in HK is due to the migration of manufacturing plants and investment from HK to Southern China. The lower cost in Mainland serves as a “pulling” force while the higher cost in HK serves as the “pushing” force for the shifting of manufacturing production to Mainland China. “Industrial hollowing” or “deindustrialization” “Industrial hollowing” refers to theshrinkage of the industrial sector.

6. 2) Shrinkage of the real sector and expansion of the nominal sector In thetransition years, the real economy (measured mainly in terms of industrial output) shrank. However, the nominal sector expanded because HK experienced an influx of “hot money” from overseas which raised the “money-deepening ratio” of HK. The money-deepening ratio is defined as the ratio of money supply to GDP (M/GDP). This ratio reflects the extent the monetary aggregate (the nominal sector) influences output and growth. Economic bubble A growing nominal sector together with a shrinking real economy weakens the sustainability of the economy when a sudden shock hits. The outbreak of the Asian financial crisis in 1997 results in the burst of the economic bubble.

7. Post 1997 Post-Olympic Syndrome “Post-Olympic Syndrome” is characterized by a fall in tourism, a drop in consumer expenditure, a rise in unemployment and a withdrawal of funds. Prior to the Olympic Games, investments and industries expand to cater for the event. When the Olympic ends, the fall in various investment results in a decline in income and an increase in unemployment rate. Asian Financial Crisis in 1997 The Asian financial crisis in July 1997 deepened and prolonged the post Olympic syndrome. There was a massive withdrawal of funds from HK by the foreign investors. 1) Decline in income and increase in unemployment 2) Three Economic Dilemmas: - Economic integration with Southern China vs competition from Southern China (due to its lower cost) - Expansionary fiscal policy to revive the economy vs a worsening fiscal deficit - Tradeoff between price stability and unemployment: inflation to boost the business vs deflation to reduce economic hardship

8. Discussion Questions on the Policy Address • What are the major structural changes that HK has gone through since WWII? • Tung said that HK is going to have another structural change in the 2000’s, what are the industries that Tung thinks HK should specialize in? • What are the economic principles of HK? Is Tung going to follow these economic principles? • How do you think the concept of “Economism” fits into Tung’s policy address?

9. Policy Address of the Chief Executive Tung Chee-hwa(1) The Changing Comparative Advantages of Hong Kong: • Before WWII: fishing port, entreport • 1950-1970: labor-intensive manufacturing China’s export declined when the National Party took over, so HK’s role as entreport also declined. Besides, HK had abundant cheap labor which made it a prefect place to develop labor intensive manufacturing • 1970’s: international banking/financial center in the Asia- Pacific region. • 1980’s: re-export revitalized due to the opening up of Mainland China to foreign trade China had abundant capital and labor resources but lacked well-functioning transportation, telecommunications and financial sectors, so it relied on HK to export its products to other countries. • 1990’s: service center e.g. insurance, financial services • 2000’s:focus on high value-added services – financial services, logistics, tourism and producer services Tung:“Our direction ... [is to develop] our position as an international financial center, a producer service center, a hub for information services and logistics and a premier tourist destination”

10. Policy Address of the Chief Executive Tung Chee-hwa (2) Hong Kong’s Economic Principles 1. Laissez-faire principle, great economic freedom Tung: “HK is a free market economy, and the prime mover of economic restructuring rests mainly with the private sector”. HK was ranked as the world’s freest economy in the Heritage Foundation’s 2003 Index of Economic Freedom for the 9th consecutive year. 2. Small Government and positive (non)-intervention Positive non-intervention means that government only maintains a suitable business environment through appropriate fiscal incentives, infrastructure provision, education and training. The government won’t actively control the functioning of the market. Tung: “We will adhere to our “big market, small government” policy…” 3. Dynamic/shifting economic advantages Tung mentioned that China’s accession to WTO gives HK a new opportunity/advantage to serve as a financial service center of Mainland which provides supporting services to Mainland’s economic development. 4. Flexible industrial structure: presence of entrepreneur and small and middle size enterprises (SME) Tung: “The vitality of our economy owes much to the numerous small and enterprises which employ many workers” 5. Viable foreign and local investments Tung: “We have decided to encourage more overseas investors to settle in HK”.

11. Policy Address of the Chief Executive Tung Chee-hwa (3) Five elements of “Economism”: Economism: Economism is a conceptual framework which consists of five basic economic concepts. These 5 economic concepts govern the successful operation of an economy. This conceptual framework is applied in a number of East Asian economies, including HK, Singapore, Taiwan and South Korea. 1. Lacking focus on income equality, more on economic growth A bigger economic pie means both the rich and the poor can achieve a higher level of absolute income, though the share may not be equal. Tung mentioned nothing about income equality in his whole policy address! 2. Government’s role as “economic fertilizer” to businesses & households Tung: “Government has to ….. invest heavily in education, upgrade economic infrastructure, promoting innovation and technology, improving business environment…..”

12. Policy Address of the Chief Executive Tung Chee-hwa (4) 3. Importance of domestic economic stability Tung: “A stable property market is one of the important elements in revitalizing HK’s economy”. 4. A “pro-growth” political regime Tung: “..only sustained economic growth can lay the foundation for improving people’s livelihood and help in taking our society forward” 5. Capitalist market economy Tung stressed that a “Market-led Approach” will be used to restructure the economy