EF3461EF3461The Economies of Mainland The Economies of Mainland

China and Hong KongChina and Hong Kong

Tutorial 2Tutorial 2Hong Kong’s economy Hong Kong’s economy

City University of Hong KongCity University of Hong Kong

Dr. Isabel YanDr. Isabel Yan

Discussion QuestionDiscussion Question

Discuss the features of Hong Kong’s economy during the transition period Discuss the features of Hong Kong’s economy during the transition period (1984-1997) and the post-1997 period based on the following article:(1984-1997) and the post-1997 period based on the following article:

• Li, Kui Wai, Li, Kui Wai, Chapter 2: Economic Performance in Transition YearsChapter 2: Economic Performance in Transition Years

Key events that marked the beginning and the end of the Key events that marked the beginning and the end of the

transition period:transition period:

19841984 : : Conclusion of the Sino-British negotiation which Conclusion of the Sino-British negotiation which laid laid down the constitutional framework for the HK down the constitutional framework for the HK Special Special

Administrative Region (HKSAR). Under this Administrative Region (HKSAR). Under this framework, HKSAR is to remain framework, HKSAR is to remain

autonomous for 50 autonomous for 50 years after July 1, 1997.years after July 1, 1997.

1997 July :1997 July : HK’s sovereignty was returned to the Mainland HK’s sovereignty was returned to the Mainland China China

Aug :Aug : Asian financial crisisAsian financial crisis

1984-19971984-1997• Short-term investment behaviorShort-term investment behavior

Investors preferred short term investment because they considered July 1997 as a 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, 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 investors tend to engage in investments that can be easily be liquidated in short notice.notice.

Speculative ActivitiesSpeculative ActivitiesSpeculative activities in stocks and real estates are typical examples of short-term Speculative activities in stocks and real estates are typical examples of short-term investment behavior.investment behavior.

Wealth effectWealth effectThe rise in demandThe rise in demand for private property drove up the price of stocks and properties. for private property drove up the price of stocks and properties. The asset appreciation in both stocks and property market reinforced each other. The asset appreciation in both stocks and property market reinforced each other. Besides, wealth expanded as asset prices appreciated.Besides, wealth expanded as asset prices appreciated.

Wage-inflation spiralWage-inflation spiralRise in aggregate demand led to higher inflation and wages in both private and 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 public sectors. The inflation in the service sector was higher than that of the manufacturing sector because the manufacturing sector was more competitive due manufacturing sector because the manufacturing sector was more competitive due to the close substitutes from import. On the contrary, the monopolistic nature of the 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.service sector allows the service sector to increase prices more rapidly.

• Structural imbalance:Structural imbalance:

1)1) Shrinkage of the manufacturing sector and expansion of the service Shrinkage of the manufacturing sector and expansion of the service sectorsector

The shrinkage of the manufacturing sector in HK is due to the migration of 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 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 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 serves as the “pushing” force for the shifting of manufacturing production to Mainland China.Mainland China.

““Industrial hollowing” or “deindustrialization”Industrial hollowing” or “deindustrialization”

““Industrial hollowing” refers to theIndustrial hollowing” refers to the shrinkage of the industrial sector.shrinkage of the industrial sector.

2)2) Shrinkage of the real sector and expansion of the nominal sector Shrinkage of the real sector and expansion of the nominal sector

In theIn the transition years, the real economy (measured mainly in terms of transition years, the real economy (measured mainly in terms of industrial output) shrank. However, the nominal sector expanded because industrial output) shrank. However, the nominal sector expanded because HK experienced an influx of “hot money” from overseas which raised the HK experienced an influx of “hot money” from overseas which raised the “money-deepening ratio” of HK. The money-deepening ratio is defined as “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 ratio of money supply to GDP (M/GDP). This ratio reflects the extent the monetary aggregate (the nominal sector) influences output and growth.the monetary aggregate (the nominal sector) influences output and growth.

Economic bubbleEconomic bubble

A growing nominal sector together with a shrinking real economy weakens A growing nominal sector together with a shrinking real economy weakens the sustainability of the economy when a sudden shock hits. The outbreak 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 of the Asian financial crisis in 1997 results in the burst of the economic bubble. bubble.

Post 1997Post 1997

1) Decline in income and increase in unemployment2) 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

Post-Olympic SyndromePost-Olympic Syndrome““Post-Olympic Syndrome” is characterized by a Post-Olympic Syndrome” is characterized by a fall in tourism, a drop in consumer expenditure, fall in tourism, a drop in consumer expenditure, a rise in unemployment and a withdrawal of a rise in unemployment and a withdrawal of funds. Prior to the Olympic Games, investments funds. Prior to the Olympic Games, investments and industries expand to cater for the event. and industries expand to cater for the event. When the Olympic ends, the fall in various When the Olympic ends, the fall in various investment results in a decline in income and an investment results in a decline in income and an increase in unemployment rate.increase in unemployment rate.

Asian Financial Crisis in 1997Asian Financial Crisis in 1997

The Asian financial crisis in July The Asian financial crisis in July 1997 deepened and prolonged the 1997 deepened and prolonged the post Olympic syndrome. There was a post Olympic syndrome. There was a massive withdrawal of funds from massive withdrawal of funds from HK by the foreign investors.HK by the foreign investors.

Discussion Questions on the Policy AddressDiscussion Questions on the Policy Address What are the major structural changes that HK has What are the major structural changes that HK has

gone through since WWII? gone through since WWII? Tung said that HK is going to have another structural Tung said that HK is going to have another structural

change in the 2000’s, what are the industries that change in the 2000’s, what are the industries that Tung thinks HK should specialize in?Tung thinks HK should specialize in?

What are the economic principles of HK? Is Tung What are the economic principles of HK? Is Tung going to follow these economic principles?going to follow these economic principles?

How do you think the concept of “Economism” fits How do you think the concept of “Economism” fits into Tung’s policy address?into Tung’s policy address?

Policy Address of the Chief Executive Tung Chee-hwaPolicy Address of the Chief Executive Tung Chee-hwa

(1)(1) The Changing Comparative Advantages of Hong Kong:The Changing Comparative Advantages of Hong Kong:

• Before WWII:Before WWII: fishing port, entreportfishing port, entreport• 1950-1970:1950-1970: labor-intensive manufacturinglabor-intensive manufacturing

China’s export declined when the National Party China’s export declined when the National Party took over, so HK’s role as entreport also declined. took over, so HK’s role as entreport also declined.

Besides, Besides, HK had abundant cheap labor which made HK had abundant cheap labor which made it a prefect place to it a prefect place to develop labor intensive develop labor intensive manufacturing manufacturing

• 1970’s:1970’s: international banking/financial center in the Asia-international banking/financial center in the Asia-Pacific region.Pacific region.

• 1980’s:1980’s: re-export revitalized due to the opening up of re-export revitalized due to the opening up of Mainland China to foreign tradeMainland China to foreign tradeChina had abundant capital and labor resources but lacked well-China had abundant capital and labor resources but lacked well-

functioning functioning transportation, telecommunications and financial sectors, so it transportation, telecommunications and financial sectors, so it relied on HK relied on HK to export its products to other countries.to export its products to other countries.

• 1990’s:1990’s: service center e.g. insurance, financial servicesservice center e.g. insurance, financial services• 2000’s:2000’s: focus on high value-added services – financial focus on high value-added services – financial

services, logistics, tourism and producer servicesservices, 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”

Policy Address of the Chief Executive Tung Chee-hwa (2)Policy Address of the Chief Executive Tung Chee-hwa (2)

Hong Kong’s Economic PrinciplesHong Kong’s Economic Principles1.1. Laissez-faire principle, great economic freedomLaissez-faire principle, great economic freedom

Tung: “HK is a free market economy, and the prime mover of economic restructuring rests 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 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 9Foundation’s 2003 Index of Economic Freedom for the 9 thth consecutive year. consecutive year.

2.2. Small Government and positive (non)-interventionSmall Government and positive (non)-interventionPositive non-intervention means that government only maintains a suitable Positive non-intervention means that government only maintains a suitable business environment through appropriate fiscal incentives, infrastructure business environment through appropriate fiscal incentives, infrastructure provision, education and training. The government won’t actively control the provision, education and training. The government won’t actively control the functioning of the market.functioning of the market.Tung: “We will adhere to our “big market, small government” policy…”Tung: “We will adhere to our “big market, small government” policy…”

3.3. Dynamic/shifting economic advantagesDynamic/shifting economic advantages Tung mentioned that China’s accession to WTO gives HK a new opportunity/advantage to serve 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 as a financial service center of Mainland which provides supporting services to Mainland’s economic development. economic development.

4.4. Flexible industrial structure: presence of entrepreneur and small and middle size Flexible industrial structure: presence of entrepreneur and small and middle size enterprises (SME)enterprises (SME) Tung: “The vitality of our economy owes much to the numerous small and enterprises which Tung: “The vitality of our economy owes much to the numerous small and enterprises which employ many workers” employ many workers”

5.5. Viable foreign and local investmentsViable foreign and local investmentsTung: “We have decided to encourage more overseas investors to settle in HK”.Tung: “We have decided to encourage more overseas investors to settle in HK”.

Policy Address of the Chief Executive Tung Chee-hwa (3)Policy Address of the Chief Executive Tung Chee-hwa (3)

Five elements of “Economism”:Five elements of “Economism”:Economism: Economism is a conceptual framework which consists of five Economism: Economism is a conceptual framework which consists of five

basic economic concepts. These 5 economic concepts govern the basic economic concepts. These 5 economic concepts govern the successful operation of an economy. This conceptual framework is successful operation of an economy. This conceptual framework is applied in a number of East Asian economies, including HK, applied in a number of East Asian economies, including HK, Singapore, Taiwan and South Korea. Singapore, Taiwan and South Korea.

1.1. Lacking focus on income equality, more on economic growthLacking focus on income equality, more on economic growthA bigger economic pie means both the rich and the poor can A bigger economic pie means both the rich and the poor can achieve a higher level of absolute income, though the share may achieve a higher level of absolute income, though the share may not be equal.not be equal.Tung mentioned nothing about income equality in his whole Tung mentioned nothing about income equality in his whole policy address!policy address!

2.2. Government’s role as “economic fertilizer” to businesses & Government’s role as “economic fertilizer” to businesses & householdshouseholds Tung: “Government has to ….. invest heavily in education, Tung: “Government has to ….. invest heavily in education, upgrade economic infrastructure, promoting innovation and upgrade economic infrastructure, promoting innovation and technology, improving business environment…..”technology, improving business environment…..”

Policy Address of the Chief Executive Tung Chee-hwa (4)Policy Address of the Chief Executive Tung Chee-hwa (4)

3.3. Importance of domestic economic stabilityImportance of domestic economic stability Tung: “A stable property market is one of the important Tung: “A stable property market is one of the important elements in revitalizing HK’s economy”.elements in revitalizing HK’s economy”.

4.4. A “pro-growth” political regimeA “pro-growth” political regime Tung: “..only sustained economic growth can lay the Tung: “..only sustained economic growth can lay the foundation for improving people’s livelihood and help in taking foundation for improving people’s livelihood and help in taking our society forward” our society forward”

5.5. Capitalist market economyCapitalist market economyTung stressed that a “Market-led Approach” will be used to Tung stressed that a “Market-led Approach” will be used to restructure the economyrestructure the economy