Hong Kong’s Economic Future

Many warned about the economic and financial repercussions of the National Security Law on Hong Kong. To be sure, any long-term economic impacts of the law will take time to surface. We cannot tell right away from a few quarters of economic data, particularly when the pandemic has so distorted the recent results.

Given its vague definition of subversion and sweeping power it conferred to authorities, the National Security Law will not stop at persecuting opposition politicians. At the height of the debate about the extradition bill in 2019, many local tycoons and members of the mainland elite in Hong Kong expressed reservations about the bill. It was reported that a group of mainlanders even quietly lobbied Chief Executive Carrie Lam to drop the bill.

The National Security Law is more draconian than the original extradition bill, and given what has recently befallen Jack Ma and Ant Group it’s clear how volatile an entrepreneur’s fortune can become at the hands of absolute political power. Companies and wealthy individuals will naturally consider diversifying their wealth out of Hong Kong. The decision of Boyu, a princelings’ private equity fund based in Hong Kong, to start relocating to Singapore is noteworthy. Tycoons are looking at relocating their private wealth to Singapore, London, and Switzerland. A survey by the American Chamber of Commerce in Hong Kong showed four out of 10 members were considering leaving Hong Kong. International recruiters saw a surge in inquiries from bankers about leaving Hong Kong. Government data shows the number of foreign companies with a Hong Kong office—financial firms, in particular—dropped for the first time in 10 years in 2020. The Hong Kong government has taken note and reportedly contacted and probed financial executives who had left Hong Kong. Some found such phone calls from the authorities unusual.

With the authorities’ determination to tighten the screening of civil servants, teachers, judges, and many other professionals for their political loyalty, an exodus of the middle class is in the making. The U.K. government has estimated 300,000 Hong Kongers will eventually relocate to Britain under its new immigration scheme open to 5 million eligible Hong Kong residents. These emigrants would be likely to sell their homes and take their savings when relocating. Assuming these 300,000 emigrants are families with an average family size of four and a median home price of $1.2 million, this exodus could potentially draw U.S.$90 billion out of Hong Kong. Bank of America estimates the exodus could bring an outflow of U.S.$36 billion in 2021 alone.

Most Hong Kongers are still observing how much the situation can worsen under the security law, while travel is still restricted under the pandemic. All of the above are no more than warning signs. While Beijing is continuing to tighten its grip on all walks of life in Hong Kong and free elections in the city are rapidly becoming a thing of the past, many would turn the idea of “voting with one’s feet” into action.

The global economy contracted at least four percent in 2020 due to the economic shutdown to contain the coronavirus outbreak. Hong Kong is no exception. There is no doubt that Hong Kong’s economy could recover significantly this year and next, but the answer to whether its economy will regain its pre-COVID-19 peak is complicated. Once the Chinese markets are fully liberalized and internalized, the dual-role of Hong Kong as a middleman and a platform will gradually diminish. In the long run, Hong Kong will be integrated into China’s economy.

The Hong Kong Stock Exchange ranked fifth in the world in 2020 in terms of market capitalization and trading volume. Total initial public offering (IPO) funding in Hong Kong is expected to reach a record high in 2021. The main reasons for this achievement are: first, significant cash is flooding into Hong Kong via Stock Connect, which allows mutual market access to the investors between mainland China and Hong Kong; and second, because of tightened regulations in the U.S., more Chinese big tech companies such as Alibaba, Meituan, Kuaishou, and Baidu are seeking IPOs or secondary listings in Hong Kong. The easing of China’s capital controls, by allowing annual individual investment of up to U.S.$50,000 in overseas securities, will also boost Hong Kong’s financial market.

Hong Kong is still a bi-directional gateway for Chinese capital seeking overseas investment and for global investors tapping into China’s huge markets. But when the restrictions on foreign investment in China and the transfer of renminbi are relaxed, foreign and Chinese investors will be able to directly invest inside or outside of China without relying on Hong Kong. Hong Kong, Shanghai, and Shenzhen will be three financial centers on an equal footing in China.

Meanwhile, Hong Kong’s status as a trading hub and shopping paradise has been challenged by Hainan province. China is determined to transform Hainan into a free trade port with lucrative tax incentives and preferential treatment. Chinese businesses and tourists now swamp into Hainan instead of Hong Kong, particularly during the COVID-19 pandemic.

Despite the fear that Hong Kong will lose its edge as a result of the National Security Law, Hong Kong still has plenty of competitive advantages, including a vast pool of professionals, developed legal and financial systems, and a long track record of credibility and integrity. But Hong Kong’s role as a gateway to China will certainly fade along with the narrowing regulatory gap between the two economies and the opening of China’s markets. The future of Hong Kong is tightly united with China and will benefit from China’s economic rise.

Any analysis of Hong Kong’s economic future has to take two points into account. First, most businesses fundamentally do not care about repression and will continue to operate in Hong Kong for as long as it is profitable to do so. Second, Hong Kong relies heavily on its provision of legal services as a distinguishing factor.

Businesses have been perfectly happy to profit off of authoritarianism, from Volkswagen using forced labor during the Holocaust to, well, Volkswagen benefiting from forced labor as part of the ongoing atrocities against Uighurs. In the context of the People’s Republic of China, pressure from consumers and governments elsewhere in the world has, thus far, had limited effect: Corporations desperate for market access have been easily cowed by political pressure from Beijing. Even in the case of China’s continuing repression of Uighurs—which the U.S. government and others have characterized as genocide—the steady revelation of further atrocities has done little to alter corporate behavior.

As with Xinjiang, so too with Hong Kong: For as long as businesses find it profitable to operate in Hong Kong, they will continue to do so. The question is, for how much longer will it be profitable to do so?

For years, Hong Kong has sought to portray itself as an international “legal hub,” particularly one with a robust common law legal system. As I have noted previously, the preservation of the rule of law in Hong Kong has overwhelmingly been couched in terms of its being good for business. Beijing’s imposition of the National Security Law has starkly illustrated the limits of that narrative.

Hong Kong officialdom has been desperate to reassure outsiders that the territory’s legal system remains alive and well. In an event held by the Asian Academy of International Law on February 26, Secretary for Justice Teresa Cheng sought to convince an audience of legal luminaries that “Hong Kong is irreplaceable,” asserting that this was the only “fair and rational opinion.” Many corporate counsel do not agree. A Financial Times article from January 31 noted a “surge in queries from clients . . . about whether to write Hong Kong out of governing law and arbitration clauses.” Cheng’s remarks reflect the strategy of the Hong Kong and Beijing governments to bet that a sufficient number of businesses will believe that they can remain within the confines of Hong Kong’s normative state.

Yet Hong Kong’s facade is starting to crack. Australian judge James Spigelman resigned from Hong Kong’s Court of Final Appeal (CFA) in September 2020, citing the imposition of the National Security Law. The U.K. is considering whether to continue sending judges to the CFA. (A similar motion was tabled before the Law Society of Ontario Convocation on February 25, but failed.) Four days before media tycoon Jimmy Lai’s bail hearing before the CFA—unusually, involving no foreign judges—Chief Justice Andrew Cheung had a one-on-one meeting with Chief Executive Carrie Lam, prompting concerns about mainland-style “telephone justice.” Earlier this month, Citizen News reported that the CFA has left a Permanent Judge position vacant for over a month; the unusually long delay raises questions over political interference in judicial appointments. Beijing and the Hong Kong Central Government may well be right that there are businesses foolish enough to think that such developments will not affect them. But others have seen the writing on the wall.

The late Jan Morris wrote a lyrical book about Trieste, the gateway city of the Habsburg empire, now a charming backwater. Hong Kong’s fate, for a variety of reasons, seems likely to take a similar course. Will it fade from major center of commerce and the “world city” touted by the first post-1997 chief executive, Tung Chee-hwa, to a postage stamp tax haven for China’s wealthy along the lines of Luxembourg?

The big question for Hong Kong, one its local leaders seem unable to answer, is what the Hong Kong of five years or 20 years from now will look like. Politics aside, of Hong Kong’s four key industries—trading and logistics, financial services, professional services, and tourism—only financial services and its ancillary professional services currently have a bright future. Logistics is moving steadily northwards, and tourism and retail services have taken a huge and perhaps irrecoverable blow, with tourism falling by 14.2 percent in 2019 and 93.6 percent in 2020.

Hong Kong served as the fifth largest stock market globally by market capitalization in 2020 and the second largest platform for initial public offerings (IPOs) after New York. Nearly all of this spectacular growth came from mainland Chinese firms, both listings and the banks managing them. So-called “homecoming” secondary listings in Hong Kong accounted for at least one-third of funds raised out of the year-end total of U.S.$51.3 billion, while overall mainland Chinese firms made up 88 percent of total equity funds raised in Hong Kong last year, and 80 percent of market capitalization. Mainland banks now dominate these coveted IPO manager rankings.

Why the financial sector should be a standout is linked directly to China’s temporary need to keep its capital account closed, to protect its system of directed credit and control of its monetary system. Its strategy is to gradually open channels for capital flow—emphasis on gradually. The mainlandization of Hong Kong’s finance sector is a corollary of Hong Kong’s usefulness as a platform for IPOs and fund raising. It is not solely a matter of tension with the United States and pressures on Chinese firms to submit to U.S. oversight of their financial disclosures or face de-listing. It is also that for mainland Chinese firms, whether exiting a private equity venture or applying for a listing, the processes are far more arduous in Hong Kong, where the Stock Exchange of Hong Kong has put enormous effort into modernizing what once was a small, incestuous regional exchange.

Financial services will buoy the economy going forward, but the risk is that the economy becomes increasingly one-dimensional. Can a future like that of Trieste be far behind? Hong Kong’s economic future will to a large extent depend on how these new players affect employment, bring creative disruption, and develop local roots.

In September, the Australian justice James Spigelman resigned from Hong Kong’s Court of Final Appeal citing the content of the now infamous National Security law. The ongoing developments of the rather brutal implementation of the law raise numerous questions about the judicial independence of what was seen as an international legal hub for global businesses.

Judicial independence and freedom from interference were guaranteed by Article 85 of Hong Kong’s Basic Law. But the system rested on fragile grounds as the powers of interpretation and amendment of the Basic Law were given to People’s Republic of China governing bodies through Article 158 and 159. In addition, the loosely framed Article 23, which addresses the possibility of sedition or subversion, de facto rendered the democratic legacy of the British null and void. With the new Security Law, Hong Kong’s already vulnerable judicial construction is on the verge of collapse.

Long gone are the days when “one country, two systems” allowed for Hong Kong’s legal independence. The administrative region is no longer so special for global businesses. While data can be difficult to find (if not contradictory) due to the sensitive issues at play, there is plenty of anecdotal evidence of multinational corporations contemplating relocation in Singapore or Tokyo.

Of course, Hong Kong remains a top financial center and is the main Chinese hub for foreign direct investment. It is also a dynamic locale for arbitration. According to the Hong Kong International Arbitration Centre (HKIAC), arbitral case numbers are rising: In 2020, there was a nearly 20 percent increase in administered cases, 85 percent of which were international. HKIAC received a total of 318 new arbitration filings in 2020, the highest number received in a calendar year since 2009. The total amount in dispute was close to U.S.$9 billion—a record high since HKIAC began to publish such information in 2011. The arbitration system is independent from Hong Kong’s judiciary, but the business community’s confidence in it relies on the perception of Hong as a democratic and just society.

If Hong Kong’s judiciary is no longer viewed as impeccably independent, could Hong Kong remain an international dispute resolution center that attracts commercial arbitration, especially when arbitrations involve Chinese parties? What about the selection of arbitrators, their independence and impartiality? Hong Kong’s arbitral institutions might have to fight to keep their regional status when compared with Singapore, which offers the same services. How could Hong Kong come first in Asia in the World Economic Forum’s judicial independence rankings again?

The U.K. never gave democracy to its former colony, but in creating a unique system of education and justice it planted the seeds. With universities and courts under attack, the Hong Kong judicial system is now facing a final appeal to uphold what remains of the rule of law.

In June of 1995, the cover of Fortune magazine, carried a catchy headline: “The Death of Hong Kong.” The magazine’s dim prediction was largely based on Hong Kong’s post-handover outlook. Such a sentiment was shared in 2006, around a decade after the handover, by Nobel Laureate economist Milton Friedman, who (accurately, in hindsight) predicted that “although the territory may continue to grow, it will no longer be such a shining symbol of economic freedom.” Amidst the National Security Law, many commentators have predicted an exodus of companies, talents, and capital, sparking a fresh round of “the death of Hong Kong” debates.

There are reasons to feel pessimistic. As reported by South China Morning Post, foreign companies in Hong Kong face “huge insecurity” over the National Security Law. Hong Kong’s loss is its competitors’ gain. Britain, Singapore, and many other countries are anxious to capitalize on these opportunities and look to welcome with open arms the fleeing companies and people, as well as their money. In 2020, Hong Kong lost its title as the world’s freest economy to Singapore for the first time, perhaps marking a pivotal turn after decades of rivalry between the two cities. Any fears for a rapidly deteriorating democracy are not ungrounded. In late February, 47 democracy activists were charged with subversion under the National Security Law, largely for exercising their right to stand for election—as recognized by Article 26 of the Basic Law of Hong Kong. Businesses can also be affected if their representatives ever “cross the boundary” in their freedom of expression. We have seen as much in China, where many commentators speculated that the historic cancellation of Ant Group’s IPO was a result of a speech in which its founder, Jack Ma, criticized the Chinese banking system.

Are there reasons to be optimistic? Absolutely yes. Hong Kong’s people and economy have always been versatile. First a fishing village, then an entrepôt, eventually a manufacturing base (Hong Kong used to be the world’s major supplier of toys and small electronics before the rise of mainland China), and finally a financial center; all these point to the fact that Hong Kong has always managed to find its place in a forever changing business and political landscape. Thanks to the “one country, two systems” policy, Hong Kong remains different from the rest of China. It still enjoys a high degree of autonomy (though that is diminishing continually) and gets to maintain a legal system based on common law (as recognized by the Basic Law). Meanwhile, these competitive advantages are not without an expiry date, as the promises in the Basic Law are in principle only good until 2047 (50 years after the handover of Hong Kong from Britain to the People’s Republic of China). As the prospect of “one country, one system” looms, the fatal blow will be the disappearance of Hong Kong’s uniqueness. Hong Kong may well become “just another Chinese city.”

Indeed, the headlines out of Hong Kong seem incongruous: pro-democracy activists are being charged under the National Security Law, while the Hong Kong government’s GDP report forecasts positive growth for 2021. On the face of it, economic recovery seems to support the argument of the National Security Law’s proponents, that is: stability and order is in the best interest of local residents and their ability to make a livelihood. It would be easy to connect Hong Kong’s track record in containing COVID-19 to such stability and order. But some might argue that it is Hong Kong people—not the government—who are responsible for its success, citing: 1) Hong Kong’s previous experience with epidemics like SARS, 2) its vibrant grassroots society, and 3) its experience organizing in the 2019 protests.

I would look beyond short-term GDP forecasts for Hong Kong’s economic future. In particular, I am interested in measures of Hong Kong’s human capital in three arenas. First, I think it is important to understand the motivations of Hong Kong’s professional class: Are they planning an exit strategy or do they continue to see their futures, and those of their children, in Hong Kong? Second, I would look to Hong Kong’s universities as a barometer for whether Hong Kong can cultivate and also retain both local and global talent. Are Hong Kong university students getting the training they need to stay competitive? Do the innovators and entrepreneurs find that Hong Kong is a place to start a business? Third, related to the first and second, even if some of Hong Kong’s professionals plan to leave, are they being replaced by promising young people from mainland China? Or is the environment for business plus anti-mainland sentiment a deterrent?

In other words, Hong Kong’s historic economic strength is inseparable from its ability to attract human capital. This was certainly true after the second World War and the establishment of the People’s Republic, when Chinese capitalists brought their capital and experience to Hong Kong and waves of migrants provided the labor for its 1950s-1960s industrialization. The “new immigrants” of the 1970s and 1980s, as anthropologist Helen Siu has written, both reshaped Hong Kong society and helped tie it to reform-era southern China. Looking to Hong Kong’s economic future, a crucial factor will be the potential for mobility, both in terms of physical mobility and social mobility.