Master programme in Economic History

The impact of rising economic integration of Hong

Kong and China

Yuen Man Lai

yuen_man.lai.111@student.lu.se

Abstract: In the last decade, Hong Kong maintains a relatively stable and sustained economic growth compared to other developed countries despite the Asian Financial Crisis in 1997, the outburst of IT Bubble in 2001, the Severe Acute Respiratory Syndrome in 2003. This thesis suggests that integration with China is the reason for such growth. Many studies have shown that Hong Kong and China have been closely interacting economically since early 1980s, which involve the flow of goods, flow of capital and flow of people. However, most literatures mainly focus on the effect of trade integration despite the flow of people and capital between two regions has been ever increasing and encouraging. Decade ago, interaction of people was restricted as Mainland Chinese were not allowed to come to Hong Kong by means of individual visiting. Capital flow was also highly restricted by Mainland ‘s regulation on financial markets. On the contrary, no such restrictions were placed on capital and people flows from Hong Kong to China. In this thesis, I suggest that year 2003 was a millstone for a new integration relation between Hong Kong and China. After year 2003, restrictions on Chinese capital and people flow to Hong Kong have been lifted, leading to significant impact to Hong Kong’s economy. This study will focus on the extent of integration as indicated by the flow of people and capital, as well as its affects on Hong Kong’s economy. A further assessment by using regression analysis has been performed. Finally, possible negative externalities brought by integration will also be accounted.

Key words: Economic integration, impact, Hong Kong , China, People flow, Capital Flow

EKHR11 Master thesis (15 credits ECTS)June 2011 Supervisor: : Christer GunnarssoExaminer: Tobias Axelsson

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Table of ContentChapter 1 : Introduction..............................................................................................4

1.1. Aim & Justification.........................................................................................51.2. Research Question...........................................................................................51.3. Contribution of The Study...............................................................................51.4. Scope & Limitation.........................................................................................6

Chapter 2 : Background..............................................................................................62.1. Literature Review............................................................................................62.2. Historical Integration......................................................................................92.3. Reasons of Rising Integration.......................................................................11

2.3.1. Global Trend.......................................................................................112.3.2. Political Change.................................................................................112.3.3. Economic Crisis.................................................................................12

2.4. CEPA – A New Mode on Integration............................................................122.4.1. What is CEPA.....................................................................................122.4.2. Importance of CEPA..........................................................................14

Chapter 3 : Theoretical framework..........................................................................153.1. Theory of Integration....................................................................................153.2. Level of Integration.......................................................................................163.3. Why Integration............................................................................................17

Chapter 4 : Impact of Integration............................................................................184.1. The Economy of Hong Kong Since 2000.....................................................184.2. Four Key Industries.......................................................................................18

4.2.1. The Current Value Added and Employment......................................204.2.2. The Trend of the Four Key Industries................................................21

4.3. Capital Flow..................................................................................................244.3.1. Direct Investment...............................................................................254.3.2. Equity and Bond Financing................................................................26

4.4. Human Capital Flow.....................................................................................294.4.1. New Immigrant..................................................................................294.4.2. Chinese Visitors..................................................................................31

4.5. Data Analysis................................................................................................384.5.1. Data Collection & Limitation.............................................................384.5.2. Financial Services Industry................................................................384.5.3. Tourism Industry................................................................................41

Chapter 5 : Possible Negative Externalities & Obstacle on integration................435.1. Capital Flow..................................................................................................435.2. People Flow...................................................................................................43

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5.2.1. Competition for Resources.................................................................435.2.2. Crime..................................................................................................445.2.3. Public Health......................................................................................45

5.3. Obstacle and Challenge on integration.........................................................455.3.1. Marco Level.......................................................................................455.3.2. Micro Level........................................................................................465.3.3. Cope with the Challenge....................................................................46

Chapter 6 : Conclusion & Looking Ahead...............................................................476.1. Conclusion.....................................................................................................476.2. Looking Ahead..............................................................................................48

6.2.1. Strength..............................................................................................496.2.2. Threat.................................................................................................49

Reference.....................................................................................................................51Appendices...................................................................................................................55

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Table of Figure

Table 4.1. Real GDP Accumulative Growth RateTable 4.2.1.1 Value added of Key Industries in 2009Table 4.2.1.2. Employment of Key Industries in 2009Table 4.2.2.1. The Real Growth Rate of Value added from 2000-2009 Table 4.2.2.2. The Growth Rate of Share in GDP in from 2000-2009Table 4.2.2.3. The Real Growth Rate of Value added in Different PeriodsTable 4.2.2.4. The Growth Rate of Share in GDP in Different PeriodsTable 4.2.2.5. The Growth Rate of Employment from 2000-2009Table 4.2.2.6. The Growth Rate of Share of Employment from 2000-2009Graph 4.3.1.1. Number of Regional Headquarters and Local Offices In Hong Kong Graph 4.4.2.1. Total Visitors to Hong Kong from 1997-2009Table 4.4.2.1. Accumulative Growth Rate for Numbers of VisitorsTable 4.4.2.2. Average Annual Growth Rate on Numbers of VisitorsGraph 4.4.2.2. Percentage Share of Chinese and Non-Chinese visitors Graph 4.4.2.3. Percentage Share of Total Visitors’ Expense

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Chapter 1 : Introduction

Integration is a global trend. During the past decade, numbers of regional trading arrangements have been created or extended by governments to reduced trade barriers and factor mobility within regions. Economic interaction and linkages between regions are intensified by the formation of institutional organizations such as European Union, North American Free Trade Agreement, Asia-Pacific Economic Cooperation with the aim to promote closer links and welfare. Hong Kong and China is no exception.

Due to historical reasons, China has two distinct political and economic systems. China is a controlled economy while Hong Kong is a market economy. Hong Kong is a well-known international finance and trade centre in the world. Its development was fascinating. As an entrepot in early 20th Century, Hong Kong has been developed to a metropolitan in a century under the British rule. The growth of Hong Kong in 1960s to 1990s was extremely encouraging and it was named as one of the Four Asian Tigers. In July 1997, China resumed the sovereignty over Hong Kong and Hong Kong became a Special Administrative Region (HKSAR) of China. The "One Country, Two Systems" principle provides the HKSAR with a high degree of autonomy on political, economic, legal and monetary matters except for defense and foreign affairs. Hong Kong ‘s capitalist system and way of life remain unchanged for fifty years. On the other hand, with the liberalization of economy, China has been experiencing a fascinating sustained growth rate and its impact and importance to the global economy is ever intensifying. It superseded Japan as the second largest economy in the world. As such, the dynamics and interactions between a city-state and a country are appealing. Because of geographical proximity, Mainland China and Hong Kong has a very close economic relationship long before the handover. Their integration could be traced back to early 1970s where Hong Kong and China were interrelated in innumerable ways.

In the recent decade, Hong Kong maintains a relatively stable and sustained economic growth compared to other developed countries (Graph 1.1 & 1.2) despite the Asian Financial Crisis in 1997, the outburst of IT Bubble in 2001, the Severe Acute Respiratory Syndrome in 2003. Therefore, it is worthwhile to study if the integration with China was the reason behind this phenomenon. Also, rising integration with China has become a heated topic in Hong Kong recently as there is an increasingly anti-voice against further integration with China. Therefore, in this thesis, I am going to assess the impact of rising integration of Hong Kong and China in the past decade

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using empirical evidence. It will focus on the extent of integration as indicated by the flow of people and capital and its effects on the Hong Kong’s economy and the possible negative externalities brought as well. I will start with the aim and justification including my research questions, previous research, and theoretical framework, then followed by the analysis in the second part of the thesis.

1.1. Aim & JustificationThe driving force for me to carry this research is that integration has become a very heated topic since the active involvement of Chinese government to the economy of Hong Kong starting in the year 2003. The economic linkages between two regions have become more intense. Nevertheless, there is an increasingly voice against further integration with China recently. Besides, after the return of sovereignty of Hong Kong to China, most non-academic literatures pointed out that the role of China was necessary to the development of Hong Kong, even in academic literatures, most of them focus on the impact of China in the goods market. Thus, it arose my interest to study how the “China factor” affects the specific industries and what sectors in the economy from an academic perspective.

1.2. Research QuestionMy research question is “Does rising economic integration between Hong Kong and China benefit the economy of Hong Kong? If so, to which sector(s)?” The objective of the study is to review the process of historical integration between regions and the cause of rising integration, and to investigate the impact on financial service industry and tourism industry brought by the increasing flow of capital and people.

1.3. Contribution of The StudyThis study serves an academics review on the integration and to examine the relationship between Hong Kong and China in an economic perspective. Most academic literatures assess the impact of political integration of Hong Kong and China. There are few academic literatures examining the economic impact of the integration, even so, scholars focus on the effect on trade and pay little attention to other impacts on the Hong Kong’s economy. My research would contribute in the area by examinating the extent of capital flow and people flow and its impact in the economy in the past decade. It includes the effect on structural change, the impact on differences industries in the society to a deeper understanding of the interaction dynamics between a city-state and a national state.

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1.4. Scope & LimitationIn this study, I agree that integration between two regions is mutually beneficial and the effect is far more than trade impact. Therefore, this thesis will focus on examinating effects of capital flow and people flow and how these flows affect some sectors in the economy of Hong Kong, such as Financial Service Industry and Tourism Industry. The impacts of interaction being assessed are the income and employment aroused from the China factors.

Due to resource limitation, my research mainly focuses on the impact of integration from the perspective of Hong Kong. At the same time, this study would adopt a narrow focus on last decade to discuss the impact of the rising integration. Definitely, the impact of integration from the perspective of China is worth assessing. Financial Services Industry and Tourism Industry are discussed as they are the two key industries in Hong Kong economy and they have been the driving forces of Hong Kong economic growth for past 5 years and they provide growth of other sectors and create job employment. From 2005 onwards, their share in Hong Kong GDP kept rising (Census and Statistics Department of HKSAR). In order to examine the impact of integration, it is sensible to examine how these sectors have been affected empirically. Though there are lots of reasons to sustain Hong Kong economic growth, integration with China may be probably one of the factors.

Chapter 2 : Background

2.1. Literature ReviewMany studies analyse that there have a positive effect of integration between Hong Kong and China (Enright et al., 2003; Kueh, 2002). There are quite a lot of researches concerning the trade effect between Hong Kong and China since entreport trade with the mainland and related services are of the most importance to Hong Kong (Lau et al., 2004). Previous research revealed that flow of trade was more frequent since the open door policy of China in 1978 (Ash & Kueh, 2003; Kueh, 2002;Tam, 2006). These studies were usually based on the bilateral trade date between Hong Kong and China to indicate that there is an increasing cooperation between both regions.

Regarding the trade implication, Tam (2006) points out that there were two important transformations of the trade relationship between Hong Kong and China. The first one was initiated by China’s Open-door Policy which Hong Kong relocated many manufacturing firms to China. China, on the other hand benefited from the job opportunities created by Hong Kong’s continuous outsourcing. At that time, China

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specialized in the production of goods to be exported, while Hong Kong served as the intermediary that markets the goods for exporting to the rest of the world. Hong Kong’s manufacturing sector transformed from production to dealing with manufacturing management. The second transformation was in year 1997 which Hong Kong became the “Special Administrative Region” of China making the economic linkage closer. Tam concluded that Hong Kong’s economy has closely connected with China since 1978. She analyzed the economic integration between Hong Kong and China by using a regression analysis from the period from China’s open door policy to Hong Kong’s return of sovereignty to measure the effect of trade on the growth of GDP and GDP per capita. It was found that the GDP of Hong Kong was highly positively correlated with China’s real imports from Hong Kong. It is also found that the return of sovereignty only had a slight impact on Hong Kong exports to China. She further points out that geographical proximity and the different in comparative advantages of Hong Kong and China have motivated their economic cooperation through production and trade.

In a regional level, Sung (2004) also quantified the benefits and costs for the economic integration with the Pearl River Delta (PRD) in China in the last two decades. He agreed that the integration has been highly beneficial for both regions. He pointed out that integration with the PRD involved interactions through four types of markets: market for goods and services, capital market, labour market and financial market which the integration with the PRD mainly involved the goods and services markets and capital markets. Such integration brought the reallocative effects to Hong Kong from a low valued-added manufacturing center to a higher value-added service hub of PRD through outsourcing. Integration with PRD region also affected technical change and innovation and thus affecting long run economic growth in Hong Kong. He quantified the allocative effects as the income and employment generated by PRD related exports. In the study, he found that the increase in income generated by PRD-related exports from 1995 to 2002 accounted for 76% of Gross Domestic Product in the same period while for employment by PRD-related exports accounted for 85% of the growth of employment in the same period. As the growth effects are difficult to quantify, Sung discusses them qualitatively that the integration stimulated growth by producing more opportunities of learning-by-doing. Firms in Hong Kong such as Hutchison-Whampoa, Sun Hung Kai Property Holding Limited, Hong Kong and Shanghai Banking Cooperation Limited expanded and had a rapid growth and finally became the world’s biggest and most gloablised Chinese enterprises. These well-know firms were important for long run growth in Hong Kong. However, integration with PRD has its costs, first, specialization in PRD-related service led to instability in

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export earnings; and integration led to rapid structural change and thus leading to frictional unemployment. Sung (2004) also assessed the social problems brought by integration such as illegal migrant workers, crime etc. He suggested these problems could be solved by deeper integration, i.e. coordination and cooperation of two regions rather than isolation as the world was too globalized nowadays. Hung and Lo (2004) also claimed that there was a synergy effect of regional integration between Guangdong and Hong Kong and the role of Hong Kong had been changing in the process of economic integration. Fung (2008) pointed out that private sectors in Hong Kong were the contributors to promote closer economic links with the Mainland in the late 1970s and the integration has been intensified in the past decade.

The integration between Hong Kong and China was not a smooth process politically (So, 2011). So divided the integration process into two periods, from 1978 to 2003 and from 2004 onwards where the year 2003 was the milestone of the integration. In the first period, the integration between two regions was “informal and in a societal level”. For the second period, it was “state-led formal and institutional level”. Formal arrangement, Closer Economic Partnership Agreement (CEPA) was signed in that year which changed the mode of integration from one-way flow to two-way flow. In the fear of harming the autonomy of Hong Kong, such formal institutional agreement had not been arranged until 2003. Start from 2004, there has been deeper integration in different aspects, economically, geographically and socially.

Leight (2004) concluded that there has been increasing integration between the economy of China and Hong Kong across various sectors over the past decade and this has led to significant changes in the structure of Hong Kong’s economy. As integration has progressed, the business cycles of two regions has become increasingly synchronized. Macroeconomic fluctuations in China could also cause a spillover effects to Hong Kong. He also pointed out that the direct and indirect impact of the service sector liberalization component of CEPA became increasingly significant over time as removal of entry barriers to China would benefit the service industries in Hong Kong. CEPA also allows Hong Kong firms to expand their businesses into the Mainland, thus attract foreign direct investment to Hong Kong as overseas companies use Hong Kong as a regional headquarters location to support Mainland operations. Fung (2008) suggested that in order to enhance further integration with China, Hong Kong should ensure that the flows between two regions were smooth as these flows sustained Hong Kong’s competitive advantage. The flows included flow of goods, flows of funds, flows of human resources and flows of information.

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2.2. Historical IntegrationThe year 1978 appears to be a year of no significance to Hong Kong. However, this year actually marked the start of an era of economic integration with Mainland China as well as economic transformation of Hong Kong. In late 1978, Deng Xiaoping officially announced the adoption of Economic Reform and Opening and the economic development of Hong Kong and China have been tied together since then.

Before looking into the integration process, it is worthwhile to have a brief account on both Hong Kong and China’s economy before the adoption of Economic Reform and Opening. The Great Leap Forward of the 1950s and the Cultural Revolution of 1960s greatly disrupted the economic development of China. By that late 1970s, China still suffered from low living standard and production deficiency. Economic reform is imminent for restoring people’s confidence in the central government. On the contrary, Hong Kong had gone through successful industrialization since 1960s and developed into an industrial centre. Hong Kong mainly engaged in manufacturing and processing industries which were labour intensive and export oriented, where small and medium sized enterprises played an important role. The distinct discrepancy in economic development level between Hong Kong and China at the time became the catalyst of future integration.

In 1979, China established Four Special Economic Zones, namely Shenzhen, Zhuhai, Shantou and Xiamen. These Special Economic Zones aimed at attracting foreign investment and stimulating transfer of technology and production skill. Establishment of sino-foreign joint venture as well as foreign owned enterprises were allowed by the Chinese government after the long economic isolation policy. In 1986, “22 regulations” was implemented which represented a major liberalization of trade and foreign direct investment flow in China (Lee & Nicholas, 2006). Chinese government encouraged the development of manufacturing and processing industries by offering preferential policy (e.g. export tax rebate) to enterprises with foreign investment and enterprises were given increased managerial autonomy.

With 3 out of 4 Special Economic Zones (i.e. Shenzhen, Zhuhai and Shantou) located in Guangdong Province which is adjacent to Hong Kong, Chinese government’s intention of attracting Hong Kong’s investment was transparent. As mentioned above, Hong Kong largely engaged in labour intensive industries (i.e. textile, garment, plastics, electronics) at the time and the Opening Door of China was thus like a mega magnet to enterprises of Hong Kong. The abundant supply of cheap labour and low land costs, together with policy incentives offered by the Chinese government,

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attracted Hong Kong entrepreneurs to start relocating their manufacturing and processing operation to Mainland China especially to Pearl River Delta of Guangdong Province. Besides “pull factors” of the Mainland China, there were “push factors” of Hong Kong like insufficient labour, rising labour cost and soaring land prices driving the relocation of manufacturing industries. The main factors pulling investment to China were thus abundant labour and land and proximity to Hong Kong (Jones, King, Klein, 1993). Hong Kong and Guangdong Province of China shared similar culture and language, and Guangdong Province is actually hometown to many people of Hong Kong. The cultural linkage between Hong Kong and Guangdong Province was another vital reason of economic integration.

The relocation of manufacturing and processing industries to China had been accelerated since 1980s, and peaked in the 1990s. Most export-oriented enterprises of Hong Kong had established their manufacturing operation base in Mainland China, or contracted-out the manufacturing part of their business to Chinese enterprises. By taking the advantage of low production costs of Mainland China, enterprises of Hong Kong was able to focus on the development of service industry. With the gradual formation of a huge industrial cluster at Guangdong Province, Hong Kong had progressively transformed herself to be the regional service centre to Guangdong providing logistics and trade service and other professional services.

It could be said that the economic development of Hong Kong and China actually depended on each other since 1980s. Direct investment, human capital (managerial staff and professionals) and technology from Hong Kong were indispensable driving forces to the industrialization of Guangdong Province. According to a report prepared by the Federation of Hong Kong Industries (2003), it was estimated that there were 63,000 Hong Kong based companies conducting manufacturing activities in China. In the year 2001, Hong Kong owned enterprises employed approximately three millions workers in Guangdong Province. Beside direct investment and human capital, Hong Kong also acted as a platform for China to connect to the global supply chain and benefit from globalization.

As mentioned, Hong Kong’s economic integration with China also marked her own transformation. Hong Kong transformed from an industrial centre to a commercial centre that serving the hinterland and it is worthwhile to note that the transformation was so smooth and its effect on Hong Kong’s economic growth could not undermine. The modus operandi of “Front Shop (Hong Kong), Back Factory (China)” tied Hong Kong and China together and brought economic success to both regions. Yet, this

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cooperation apparently was a “one-way flow” from Hong Kong to China and this integration process has not been mainly driven by government action to promote closer links but has developed spontaneously in the wake of economy reforms in China (Jones et. al., 1993).

2.3. Reasons of Rising Integration

2.3.1. Global Trend It is an uprising trend to tie with the Chinese economy strategically due to its importance has been increasing. As mentioned in last session, the closer integration between Hong Kong and China started earliest in 1980s with China’s open door policy. China being a large hinterland for Hong Kong provided abundant supply of resources such as low wages labour and sufficient land supply. Thus, in the early 80s, the manufacturers of Hong Kong sought the opportunities to build up the labour intensive industries in China. With liberalization of the Chinese economy, it has been getting more influential to the world economy due to its big consumption and resource-supply market. With globalization on trade and its accession to the World Trade Organization (WTO) in 2001, its important has been ever increasing. China was a global locomotive of economic growth which accounted for 31% of global GDP growth (Fung 2008). China’s access to the WTO has intensified the integration process with China and the rest of the world. Most countries are willing to arrange special trading treaties with China in order to grant special privileges on trade or operating business in China. It is a global trend to keep a close tie with China strategically especially after the Asian Finance Crisis in 1997, China was less affected economically and it was in the expansion in the economic cycle and experiencing rapid economic growth. Its role has been getting more important to Asia and to the world, Hong Kong is no exception. As Hong Kong is very accessible to China, the economic interaction has been frequent. Foreign countries also take Hong Kong as a gateway to enter the Chinese Market. As such, there is an increasing integration with Hong Kong and China for the sake of economy growth.

2.3.2. Political ChangeAnother reason for the rising integration is political. Before the reversion, Hong Kong was a British colony, the relationship between Hong Kong and China was not close in national level. Thus, interaction between two governments were limited. The flows were one-way leading by Hong Kong private sectors. However, the linkage between Hong Kong and China has become closer since Hong Kong reversion to China. According to So (2011) the integration was only on one-way flow before returning.

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That means the relocation of the manufacture industries was mainly initiated by the factories owner itself rather than the mutual government support. After Hong Kong returning to China, the scenarios changed completely. Chinese government supported Hong Kong economy by signing a formal institutional arrangement – The Closer Economic Partnership Agreement in 2003 which was the first institutional arrangement between two regions in national level. As such, the connection became a two-way cooperation – “a state-led formal and institutional level”. The economic activities between regions have become more interacting thereafter.

2.3.3. Economic CrisisA few economic incidents after the handover hit Hong Kong’s economy hard that made Chinese government support Hong Kong in an economic way. First, the Asian Financial Crisis broke out right after Hong Kong’s reversion to China in July 1997, the stock market crashed and dropped more than double from 15196 in July 1997 to 7275 in August 1998. (Graph 2.3.3.) The property market was struck. This created lots of negative-equity properties in Hong Kong. Internal consumption was severely harmed and the economy as a whole was suffered from deflation. When the economy started to recover in 2001, the outburst of IT Bubble again hurt the economy, the Hang Seng Index again dropped for 40% from February 2000 to September 2001 and the IT-related industries were deeply affected and the economy was dimmed. The stock market dropped further in March 2003 due to Severe Acute Respiratory Syndrome (SARS) outbreak. Hong Kong was announced as 'Infected Areas' by World Health Organization and was issued a Tourism Warming. As such, it deeply hurt tourism-related industries in Hong Kong. The local consumption was also severely affected, the value add of property, retail, and catering service dropped 42%, 20% and 35% respectively compared to 1997 (Hong Kong Economic Yearbook, 2010). To support the economy of Hong Kong, China government arranged the CEPA agreement and implemented the Individual Visit Scheme to boost the financial services industries and tourism-related industries in Hong Kong. It added momentum to the whole economy and the influence of China factors has become more important to Hong Kong thereafter.

2.4. CEPA – A New Mode on Integration

2.4.1. What is CEPAThe year of 2003 can be taken as a millstone on the integration between Hong Kong and China as the first institutional arrangement “Mainland and Hong Kong Closer Economic Partnership Arrangement” (CEPA) was signed in June between two sides

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and became effective in January 2004. It was a free trade agreement between two regions. The aim of CEPA is to promote economic prosperity and development and to facilitate the further development of economic links between two regions; to strengthen trade and investment cooperation through the implementation of the progressively reducing or eliminating tariff and non-tariff barriers on substantially all the trade in goods between the two sides; progressively achieving liberalization of trade in services through reduction or elimination of substantially all discriminatory measures; promoting trade and investment facilitation. (Trade and Industry Department HKSAR)

Under CEPA, Hong Kong enjoys special privileges on trade of goods and services compared to the practices enjoyed by other countries provided by China under the WTO arrangement. For goods, the Mainland will apply zero tariff to the import of those goods of Hong Kong origin. The Mainland will not apply tariff rate quota to goods of Hong Kong origin. For trades of services, some extract are taken from the main text of CEPA as below. As this thesis is not going to assess the impact of the CEPA arrangement in detail, whilst, it will highlight the part related to this thesis i.e. to enhance the capital flow and people flow between two regions.

Extract from the Main text of CEPA: 1 Article 13 Financial Cooperation

The two sides shall adopt the following measures to further strengthen cooperation in the areas of banking, securities and insurance :

1. The Mainland supports wholly state-owned commercial banks and certain joint-equity commercial banks in re-locating their international treasury and foreign exchange trading centres to Hong Kong.

2. The Mainland supports its banks in developing network and business activities in Hong Kong through acquisition.

3. The Mainland supports the full utilization of financial intermediaries in Hong Kong during the process of reform, restructuring and development of the financial sector in the Mainland.

4. The two sides shall strengthen cooperation and information sharing between their

1 From Trade and Industry Department HKSAR : http://www.tid.gov.hk/english/cepa/legaltext/fulltext.html

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financial regulators.

5. The Mainland shall, in line with the principles of observing market rules and enhancing regulatory efficiency, support eligible Mainland insurance companies and other companies, including private enterprises, in listing in Hong Kong.

Article 14 Cooperation in Tourism1. In order to further promote the development of the tourism industry of Hong

Kong, the Mainland will allow residents in Guangdong Province to visit Hong Kong individually. This measure will be implemented on a trial basis first in Dongguan, Zhongshan and Jiangmen and it will be extended to the entire Guangdong Province no later than 1 July 2004.

2. The two sides shall strengthen cooperation in tourism promotion, including promotion of tourism between each other and development of external promotion programmes centered around the Pearl River Delta.

3. The two sides shall cooperate to raise the service standards of their tourism industries and protect the legitimate rights and interests of tourists.

Article 15 Mutual Recognition of Professional Qualifications1. The two sides shall encourage mutual recognition of professional qualifications

and promote the exchange of professional talents between each other.

2. Competent authorities and professional bodies of both sides will, in consultation with each other, consider and design specific methodologies for mutual recognition of professional qualifications.

2.4.2. Importance of CEPA Before the arrangement, Hong Kong’s capital and tourists were free to enter Mainland China, whilst reverse flows were controlled. Capital flow from China to Hong Kong was highly restricted by Mainland ‘s regulation on financial markets while the interaction of people was also restricted by Hong Kong Immigration Control and the Chinese government (Sung, 2004). The flow of people was limited to business visits and group visiting. CEPA changed the rule of the game and the restriction on flow of capital and people were lifted. CEPA also gave Hong Kong’s firm access to financial sectors two years before foreign firms under the WTO arrangements and with lower entrance requirement. As such, Hong Kong firms could take this opportunity to enter

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the Chinese market before other international firms and benefit from early entry. Leight(2004) agreed that CEPA allowed Hong Kong firms to expand their businesses in the Mainland and attract foreign direct investment to Hong Kong as overseas companies take Hong Kong as a regional headquarters location to support the Mainland operations.

This arrangement was a starting point for a new mode on the existing cooperation relationship- from a regional and societal level to a state-led formal and institutional. This would be expected that the cooperation between two regions in the area of banking, securities and insurance and tourism industry would be strengthen under CEPA arrangement. The cooperation under these areas seems benefit to Hong Kong as it does not only facilitate the movement of goods but also the capital and people flow in the later year which exert a great impact on Hong Kong’s economy.

Chapter 3 : Theoretical framework

3.1. Theory of Integration

Definition of terms / conceptsAccording to the Oxford Dictionary of Economics (3rd ed. 2009), integration refers the combination of different economic activities under united control. This may involve vertical integration and horizontal integration. The organization of economic activities so that national boundaries do not matter. Complete economic integration would imply free trade in all goods and services, perfect capital mobility, compete freedom of migration, complete freedom of establishment for business and an unhindered flow of information and ideas.

In Merriam-Webster dictionary, it defines integration as “the act or process or an instance of integrating, the incorporation as equals into society or an organization of individuals of different groups”. Hans an Ginkel & Luk (2003) also suggest integration refers to the process by which states within a particular region increase their level of interaction with regard to economic, security, political, and also social and cultural issues.

Balassa(1962) was the one who proposed the term “economic integration” academically, he defined integration as a process and as a state of affairs. Regarded as a process, as it encompasses measures designed to abolish discrimination between economic units belonging to different national states; viewed as a state of affairs, it

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can be represented by the absence of various forms of discrimination between national economies.

El-Agraa (1989) further pointed out economic integration involves the amalgamation of separate economies into larger regions. It is concerned with the removal of all trade impediments between the participating nations and with the establishment of certain elements of cooperation and coordination between them.

In conclusion, “integration” refers to interacting activity between regions which include the flow of goods, services, capital and people with the removal of barriers. In my research study, rising integration is defined as increasing interaction and strengthened economic linkages between regions. It could be quantified by the increasing flow.

3.2. Level of Integration According to Balassa(1962), economic integration can take several forms that presents a varying degree of integration. They include:

i. Free Trade Areas: the member nations remove all trade impediments among themselves but retain their freedom with regard to the determination of their policies.

ii. Customs Unions: every similar to free trade are except that member nations must conduct and purse common external commercial relations, such as common external tariffs.

iii. Common Market: are customs unions that also allow for free factor mobility across national member frontiers such as capital , labour.

iv. Complete Economic Unions: are common markets that ask for complete unification of monetary and fiscal policies

v. Complete Political Integration where the participants become literally one nation, i.e. the central authority not only controls monetary and fiscal policies as in (iv) but also responsible to a central parliament with the sovereignty of a nation’s government.

As further pointed out by El-Agraa (1989), economic integration has recently come to mean not only the internationalization of the markets for goods and services but also those of capital and labor, technology and entrepreneurship, money and credit as well as the supporting economic institutions.

From the nature of the integration, it involves the flow of goods, capital and human

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capital. The flow of goods is the most primary level of integration as specific in (i) free trade areas, while followed by factors of production such as capital and labour in (ii) and (iii). Hong Kong and China can hardly be categorized into any form of the above integration as their relation is quite unique and complicated and is never only economic in nature but also political and institutional. Hong Kong is a free trading port and capital can flow freely in and out of the city. While for China, it still maintains tariff on imported products to other countries but not to Hong Kong originated goods. Still we can borrow some theories regarding the integration to assess their relationship and its impact. As pointed out by El-Agraa (1989), “the institutional aspects of economic integration cannot be measured with statistical indicators but their effects will be reflected in the level and composition trade and other sorts of measurable economic links among the members of an integrated area.” In my thesis, the effects are examined in forms of other measurable economic links, i.e. income and employment of Hong Kong.

3.3. Why IntegrationThere are lots of examples of economic integration set up such as European Community, the East African Community, the European Free Trade Association, and the Association of South-East Asian Nations for political reason in favour of economic gains. The main objectives of economic integration are of economic nature, for example, higher growth, hence more propensity. El-Agraa (1989) suggests that there are few economic gains from integration:“At the customs union and free trade area level, the possible sources of economic gain can be attributed to:

i. Enhanced efficiency in production made possible by increased specialization in accordance with the law of comparative advantage;

ii. Increased production level due to better exploitation of economies of scale made possible by the increased size of the market;

iii. An improved international bargaining position, made possible by the larger size, leading to better terms of trade;

iv. Enforced changes in economic efficiency brought about by enhanced competition; and

v. Changes affecting both the amount and quality of the factors of production due to technological advances.

If the level of economic integration proceeds beyond the Customs Unions(CU) level, to the Common Market(CM) or Economic Union( EU) level, then further sources of gain become possible due to : factor mobility across the borders of member nations; the coordination of monetary and fiscal policies; and the goals of near full

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employment, higher rates of economic growth and better income distribution becoming unified targets” ( El-Agraa 1989) .

There are a lot of positive effects regarding integration. Balassa (1962: 16) concluded that the ultimate objective of economic activity is an increase in welfare. To conclude, the initiative of integration is to improve the welfares of a nation, put it in an economic term, integration promotes economic benefits between regions. In my study, “welfare” is quantified as the value added generated and the workforce employed in different sectors in Hong Kong as the empirical evidences to prove the impact of integration with China.

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Chapter 4 : Impact of Integration

4.1. The Economy of Hong Kong Since 2000Hong Kong used to be named as “Asian Tiger” and experienced a fantastic growth rate from 1970s to 90s. In the recent decade, its economy has been expanding with the real GDP growth rate of 9.8% and an average annual growth rate of 2 % (Census and Statistics Department HKSAR).

Table 4.1. Real GDP Accumulative Growth RatePeriod 2000-2009 2000-2003 2003-2009GDP Growth Rate 9.8% -16.8% 31.9%*Constant price in year 2009Source: Census and Statistics Department HKSAR

According to the CEPA implementation year, we divide the period into two periods to assess the change. Due to the poor external economic condition, the economy got a negative growth in GDP from 2000 to 2003 but soon it took up the momentum and enjoyed a rapid growth from 2003 to 2009 of 31.9%. The growth was promising in the second period.

As Hong Kong itself does not process natural resources, riding on the right time of the economic reform in China, Hong Kong has been transformed from a manufacturing city to a service centre serving Mainland hinterland. Hong Kong’s economy has become increasingly service-oriented and the secondary sector has been diminishing since 1980s. The tertiary sector comprises of the wholesale, retail and import/export trades, restaurants and hotels, transport, storage and communications, finance, insurance, real estate and business services, community, social and personal services. The contribution of the tertiary sector has increased in the past decades. Its share of GDP rose visibly, from 73% in 1988 to 86 % in 1998 and 92 % in 2008(Graph 4.1.). The share of employment in tertiary sector followed this trend as well. The share of the tertiary sector in total employment rose steadily from 59.7% in 1989 to 82 % in 1999 and 88% in 2009. At the same time, the share of employment for secondary sector had a sharp reduced to11.8% in 2009(Graph 4.2.).

4.2. Four Key Industries Within the tertiary sector, there were four key industries that contributed most to the

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value added2 of GDP of Hong Kong, namely Financial Services, Trading and Logistics, Tourism and Producer and Professional Service. According to the classification by Hong Kong Statistics Department, the sectors of different industries covered as below: 3

i. Financial services cover a wide range of services including banking, insurance, stock brokerage, asset management, and other financial services.

ii. Logistics refers to the process of planning, implementing and controlling the movement and storage of goods (including raw materials, goods in progress and finished goods), services and related information from the point of origin to the point of consumption.  The activities include freight transport, freight forwarding, storage, postal and courier services.  Trading firms are closely associated with logistics activities. 

iii. Tourism covers inbound tourism and outbound tourism. Inbound tourism covers retail trade, accommodation services, food and beverage services, other personal services, travel agency, reservation service and related activities, and passenger transport services, yet pertaining only to that segment of services provided to visitors to Hong Kong. Outbound tourism covers travel agency, reservation service and related activities as well as cross-boundary passenger transport services, yet pertaining only to that segment of services provided to Hong Kong residents traveling abroad.

iv. Professional services cover legal, accounting, auditing, architecture and engineering activities, technical testing and analysis, scientific research and development, management and management consultancy activities, information technology related services, advertising, specialised design and related services etc, Producer services refer to services for use by other companies (i.e. intermediate consumption) in the local economy, as well as exports of services to companies and individuals. 

2 Under the production approach, GDP is the sum of the value added of resident producing units, e.g. factories, shops, service organizations. GDP by economic activities shows the value added of individual economic activities. GDP by economic activities produces data to support sectoral analyses from various perspectives which analysing the longer-term trend in the relative importance of different economic activities. This also facilitates analysis of the source of growth of an economy. From the official definition from Census and Statistics Department HKSAR.3 Classification of Four Key Industries in Hong Kong, from Census and Statistics Department of Hong Kong http://www.censtatd.gov.hk/hong_kong_statistics/four_key_industries/four_key_industries/index.jsp

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4.2.1. The Current Value Added and EmploymentThe Four Key Industries have been the driving forces of Hong Kong economic growth for past 5 years and they provide growth of other sectors and create employment. From 2005 onwards, their share in Hong Kong GDP is over 55% (Census and Statistics Department HKSAR).

Table 4.2.1.1 Value added of Key Industries in 2009Industry Value Added

(in HK Million Dollar)Percentage Share to GDP

Financial Services 235,600 15.2Tourism 50,900 3.3Trading and Logistics 373,400 24.1Professional and Producer services

202,800 13.1

Four Key Industries 862,600 55.6Souce: Census and Statistics Department HKSAR

Table 4.2.1.2. Employment of Key Industries in 2009Industry Employment Percentage Share to Total

EmploymentFinancial Services 212,000 6.1Tourism 193,200 5.5Trading and Logistics 787,900 22.6Professional and Producer services

457,800 13.1

Four Key Industries 1,650,900 47.3Souce: Census and Statistics Department HKSAR

In 2009, Trading and Logistics Industry contributed most to the GDP of Hong Kong of 24.1% and accounts for 22.6% of total employment. Second contributor was the Financial Services industry of 15.2% and 6.1% of total employment. Professional and Producer Industries contributed to 13.1% GDP and 13.1% of total employment. Finally, Tourism industry accounted for 3.3% of GDP and 5.5% of employment share. Taken together, these four key industries generated value added of HK$862.6 billion or 55.6% of GDP and employed over 1.65million labour which was 47% to the total employment. (Graph 4.2.1.1. & Graph 4.2.1.2.)

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4.2.2. The Trend of the Four Key IndustriesBefore assessing the impact from the “China Factor” on some sectors, lets look at the growth of the Four Industries and their changes.

Value added Table 4.2.2.1. The Real Growth Rate of Value added from 2000-2009 Industry/Period 2000-2009 Rank of Highest Real Growth RateFinancial Services 38.5% 2Tourism 46.8% 1Trading and Logistics 9.5% 4Professional and Producer Services

31.2% 3

GDP 23.1% NA*Constant price in year 2009Souce: Census and Statistics Department HKSAR

Table 4.2.2.2. The Growth Rate of Share in GDP in from 2000-2009Industry/Period 2000-2009 Rank of Highest Growth in Percentage

ShareFinancial Services 27.7% 2Tourism 37.5% 1Trading and Logistics 1.26% 4Professional and Producer Services

21.3% 3

Souce: Census and Statistics Department HKSAR

The highest growth rate of value added industry from period 2000 to 2009 was the Tourism Industry (46.8%) followed by Financial Services Industry (38.5%) and Professional Services Industry (31.2%), lastly was the Trading and Logistics Industry (9.5%). While for the grow in the proportion share, the pattern was the same as the real growth rate: Tourism, Financial Services, Professional and Producer Services; and lastly Trading and Logistics Industry.

Tourism Industry and Financial Service Industry experienced a high growth rate and high growth in share of GDP compared to other industries. The value added of Tourism industry grew 46.8% from 2000-2009 with the growth of 37.5 % in GDP share. The value added of Financial Service industry grew 38.5% from 2000-2009

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with the growth of 27.7% in GDP share. The value added of both industries was higher than the GDP growth at the same period. When we take a look in different periods, it could be seen that the CEPA year was an important year.

Table 4.2.2.3. The Real Growth Rate of Value added in Different PeriodsIndustry/Period 2000-2009 2000-2003 2003-2009Financial Services 38.5% -12% 57.4%Tourism 46.8% -17% 75.8%Trading and Logistics 9.5% -6.2% 16.7%Professional and Producer Services

31.2% -14.4% 53.3%

GDP 23.1% -6.4% 31.4%*Constant price in year 2009Souce: Census and Statistics Department HKSAR

Table 4.2.2.4. The Growth Rate of Share in GDP in Different PeriodsIndustry/Period 2000-2009 2000-2003 2003-2009Financial Services 27.7% 3.4% 23.6%Tourism 37.5% 0% 37.5%Trading and Logistics 1.26% 10.5% -8.4%Professional and Producer Services

21.3% 0.9% 20.2%

Souce: Census and Statistics Department HKSAR

When the period was divided according to the implementation of the CEPA in January 2004, the growth rate in each industry was very obvious( Table 4.2.2.3.). From year 2000-2003, Hong Kong economy experienced a hard time with negative growth of 6.4% in GDP. These key industries had a negative growth rate as well. Due to the SARS impact, the value added of tourism industry was severely affected with a negative growth rate of 17%. For Financial Services Industry, it could not stay away from the effect too, it experienced 12% of negative growth rate.

The situation was changed completely after year 2003. In the period 2003-2009, all industries experienced a very positive growth when the economy was recovering. The highest growth of value added among the industries was the Tourism Industry with a growth rate of 75.8% and the percentage growth in share by 37.5, followed by the Financial Industry of 57.4% growth in value added and the share of GDP increased by

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23.6% and the real growth of Professional Service Industry was 53.3% and the share increased by 20.2%, lastly was Trading and Logistics Industry which the growth in value added was the minimal of 16.7% and the relatively share in GDP was decreasing(-8.4%). Both GDP growth rate of Tourism and Financial Service Industry exceeded the GDP growth rate (31.4%).

From the above short analysis, we can see that the value added and contribution of Tourism and Financial Industries to the GDP were increasing compared to Trading and Logistics Industry. The result was made a big different in the year 2003. The “China factor” was the cause of such big growth that CEPA was the institutional tool that facilitated the flow of capital and people between regions. Tourism and Financial Industries has been exerting an increasing influence in the economy of Hong Kong.

Employment Table 4.2.2.5. The Growth Rate of Employment from 2000-2009Industry/Period 2000-2009 2000-2003 2003-2009Financial Services 25.9% -0.6% 26.6%Tourism 68% 21.5% 38.3%Trading and Logistics

2.6% 1.9% 4.6%

Professional and Producer services

27.8% 7.5% 18.9%

Employment 8.6% 0.3% 8.9%Souce: Census and Statistics Department HKSAR

For the employment growth rate, the growth was 8.6% in the whole period. The growth of employment in different industries ranked as follows: Tourism (68%), Professional Services (27.8%), Financial Services (25.6%) and finally Trading and Logistics (2.6%). When the period was divided, it could be clearly show that the employment growth in the 2nd period was very rapid in general especially in the Financial Services and Tourism industries. Tourism Industry enjoyed a sustained growth rate on employment over the decade. The growth rate of the employment in Trading and Logistics Industry was the least (4.6%) (Table 4.2.2.5.).

Table 4.2.2.6. The Growth Rate of Share of Employment from 2000-2009Industry/Period 2000-2009 2000-2003 2003-2009Financial Services 17.3% 0% 17.3%

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Tourism 52.8% 22.2% 25%Trading and Logistics

-5.4% -1.7% -3.8%

Professional and Producer services

17% 7.1% 9.2%

Souce: Census and Statistics Department HKSAR

For the growth in percentage share to total employment in whole period, Tourism was speedy (52.8%) while Financial Services and Professional Services Industry also had a high growth of 17.3% and 9.2% respectively. Only Trading and Logistics Industry got a negative growth in share.

When the period is divided into two, in the first period, only Tourism and Professional and Producer Service got a positive growth rate. The growth of share increased in the 2nd period for all industries except for Trading and Logistics which experienced a negative growth rate on employment share. The trend of share in this industry kept falling. In contrast, Tourism had a sustained growth in the share of employment.

From the above short analysis, we can see that the employment and the employment share of Tourism and Financial Service Industries were increasing compared to the Trading and Logistics Industry which the growth rate has been deteriorating. This could be explained that integration with China was the cause of such growth for Tourism and Financial Services Industries. Both industries has been expanding after the year 2003 when movement of capital and people became more frequent and thus employed more workforces. The importance of these two markets has been rising in Hong Kong.

As discussed in the last few session, the interaction of good market is not a novel topic. Concerning the level of integration, the good market is always the first market to be integrated followed by factor market - capital and people. Besides, as analyzed in this session, it has evidenced that the Financial Services Industry and Tourism Industry experienced a promising growth and played an increasing role in the Hong Kong’s economy in the last decade especially after the year 2003. Therefore, in the latter session, a further analysis on how to integrate with China- by the measure of capital flow and people flow, cause changes in the value added and employment in these two sectors.

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4.3. Capital FlowThe economic linkages between Hong Kong and China have been strengthened in recent decade. Hong Kong has been the most important source of foreign capital for China. The form of financing includes direct investment (DI), equity and bond financing. These involve the moment of capital between two regions.

4.3.1. Direct Investment China is always the destination for Hong Kong companies to invest, and Hong Kong is the favored place for Chinese companies to invest as well. From 1998, China has replaced UK as the major source of inward direct investment in Hong Kong. (Hong Kong Yearbook, 2010) The share of total inward capital flow from China to Hong Kong was triple from year 1998 to 2009 from 12.3% to 36.4%. The accumulative inflow of fund rose from HK$214billion to HK$ 2,644 billion (Graph 4.3.1.1) and the share of capital inflow during the year has been raised from 17.6 % to 47% from 1997 to 2009 (Annual Digest Statistics HKSAR, 2009). These new investment and funding benefited different sectors in the economy. According to the economic yearbook of 2010, it reported that these new capital mainly used in multinational corporation’s branches and subsidiaries operating in Hong Kong. The funds also flew to property, investment holding and other commercial service then to trade, retails and wholes industry and banking (Hong Kong Economic Yearbook, 2010). Twenty branches of mainland banks accounted for 16% of total assets and 21% of deposits in the banking system of Hong Kong. (Lau et al., 2004)

Hong Kong was the prime source of foreign direct investment to China. By the end of 2009, the total cumulative value worth HK$3,067.0 billion accounting for 41.9% of the national total. The inflow inward investment to China was mainly to Guangdong Province due to its geographical proximity to Hong Kong. In 2009, the cumulative value of the direct investment in Guangdong was estimated at HK$1,108.2 billion. More than 107,000 Hong Kong-invested enterprises have been approved by the Guangdong Province (Guangdong Yearbook, 2009). Sung and Wong (2000) quantified the effects of the China factor on Hong Kong’s growth. They estimated that Hong Kong’s direct investment in the Mainland raised the return to Hong Kong capital causing the growth rate raised 1.5 % in the late 1980s as the investment flow had a positive effect on Hong Kong’s growth through stimulating investment in Hong Kong.

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Graph 4.3.1.1. Number of Regional Headquarters and Local Offices In Hong Kong

Souce: Census and Statistics Department HKSAR

Hong Kong not only acts as the gateway for China to enter the world but also as a platform for foreign companies to enter to China. The numbers of foreign headquarters and offices in Hong Kong increased by 42 % between 1997 and 2009, to 3580. (Census and Statistics Department HKSAR) The major territories of these companies were from United States, Japan and United Kingdom. The Officer of Trade Development Council of Hong Kong (Lee, 2007) points out that geographical proximity to China is the main attraction to foreign companies to set up headquarters and branches in Hong Kong. It is estimated that around 2000 mainland related companies are operating in Hong Kong and participate mainly in real estate, insurance, trading and finance sectors. (Lau et al., 2004) By the end of 2009, there were 127 and 96 companies from the Mainland set up regional offices and regional headquarters respectively in Hong Kong that were mainly engaged in finance and banking, import and export trade, wholesale and retail, transportation, storage and courier services, professional and business services, real estate and information technology services etc. (Hong Kong Yearbook, 2009) The direct impact for these new branches were generating new income in the region plus employing more workforce to work in related fields.

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4.3.2. Equity and Bond FinancingBesides growing investments, the increasing presence of “Chinese Factor” on the Hong Kong Stock Exchange have also contributed to the economic prosperity of Hong Kong (Huang, 1997). Hong Kong becomes a fund raising platform for China. In 2009, Hong Kong Stock Exchange was ranked 4th in the world and 2nd in Asia as in terms of total equity funds raised which amounted to $642 billion. Riding on rapid economic development in China, many Chinese enterprises require capital for advancing their businesses and extend their overseas market. As an international financial centre, Hong Kong is a favorable place for raising capital. The flow of capital between China and Hong Kong is more frequent in recent decade. Hong Kong becomes a fund raising platform for China since July 1993, when the first Chinese incorporated company, Tsingtao Brewery Company Limited got listed on the Hong Kong Stock Exchange. Ever since 1997, the number of Mainland-affiliated enterprises raising fund in Hong Kong keeps increasing. In 2009, equity funds raised by Mainland enterprises amounted to HK$346 billion, which was 55 % of the total equity funds rose through the exchange during the year (Hong Kong Yearbook, 2009). About HK$201 billion was raised as new listings of Mainland enterprises in Hong Kong, accounting for 83 % of the total equity funds raised in Initial Public Offering (IPO) on the exchange. Hong Kong has come a prime fund raising centre for these enterprises (Graph 4.3.2.).

Market Capitalization Chinese Enterprises contribute largely to the market capitalization in the stock market of Hong Kong. Hong Kong Stock Exchange was ranked 7th in the world and 3rd in Asian in terms of market capitalization which rose by 74 per cent to $17,874 billion in 2009(Hong Kong Yearbook, 2009). Mainland enterprises listed in Hong Kong are classified into three categories: H-share companies, Red Chip companies and Non-H share Mainland private enterprises.4 The share of Chinese-affiliated enterprises in the market capitalization of the Hong Kong stock market rose rapidly from16% at the end of 1997 to over 45% as of April 2011 (Graph 4.3.2.1.). Totally, there are 163 H -share Chinese incorporated companies and 103 Red chips companies listed in Hong Kong respectively. This is equivalent to one third of the total number of listed companies in Hong Kong. In 2009, these Chinese-affiliated enterprises contributed to over 48% and 32% of market capitalization in Main Board and Growth Enterprise Market in Hong Kong stock Market respectively.

4 H-share are shares of mainland-incorporated companies listed in Hong Kong while “Red Chips” are shares of Hong Kong-incorporated companies with a controlling stake held by state-owned organizations or provincial/municipal authorities on the mainland.

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Market Turnover For the turnover of Chinese Stock (including both H-share and red chips), by end 2009, they contributed to over 66% of equity turnover compared to 44% in 2003 and 38% in 1997 (Graph 4.3.2.2.) .The growth of turn over rate is around 34% showing the attractiveness of these companies by investors and shows the importance of the Chinese enterprises to the Hong Kong stock market and hence in financial industry. These Chinese Stocks play an important role in financial market as they are not only popular to local investors but also attract international investors.

These fund-raising activities are mainly in the form of Initial Public Offering (IPO) in Hong Kong. In 2009, Hong Kong was ranked first worldwide in terms of IPO funds raised (Hong Kong Yearbook, 2009). It brought big business opportunities in financial services industries which comprised banks, non-bank financial institutions, asset management and insurance companies. Having a company get listed, it is required to fulfill lots of regulations by Hong Kong Stock Exchange, thus, tangibly the commission generated by an IPO is enormous. It brings new business to financial services industry such as legal advise, accounting, auditing etc. Besides initial public offering, Mainland enterprises also raise capital through the issuance of bonds which require access to investment banking services for mergers and acquisitions, and consultancy on restructuring. According to a report prepared for Bauhinia Foundation Research Centre(2008), it examined that IPO had a spill over effect on the economy. As it can “creates a healthier and more balanced growth of the financial industry fostered by the stronger ecology would in turn, create a new employment opportunities and contribution to the overall growth of the economy through stimulating additional consumption and investment spending.”

Intangibly, the growing numbers of Mainland issuers in Hong Kong have widened the breadth and depth of Hong Kong’s securities and futures markets as different sectors such as utility, energy, telecommunication and heavy industry get listed in the Hong Kong market. Previously, the financial market was highly concentrated on property business; now, there is a greater diversity on the nature of stocks. Thus, it attracts more international investors to Hong Kong and new funding from some investment companies overseas. As mentioned, when these overseas companies would like to participate in those Chinese stake, they invest in Hong Kong stock market as it gives investors access to most of the major economic sectors in China and because of its sound financial and legal system. Thus, with increasing numbers of Chinese stocks, they help to strengthen Hong Kong as an international financial centre and attract

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investors from around the world (Fung, 2008). These intangible effects could not be estimated. It brings a series of income chain to Hong Kong’s economy. It could be expected that the growth factor of the security market come from Chinese enterprises. All in all, the growing presence of Chinese-affiliated enterprises and the their capital raising activities has contributed to the development of the financial market and make Hong Kong as a leading fund raising capital and an international financial centre.

From the above analysis, the Financial Service Industry in Hong Kong has greatly benefited from the integration with China and lead to a growth in the industry. Due to the expansion of the sectors, it benefited industry-related employment. This may explained why from 2003 to 2006, Financial Services Industry experienced a growth of 57.4% and 26.6% in value added and employment respectively (Table 4.2.2.3. & Table 4.2.2.5.). A report by Economic Analysis and Business Facilitation Unit concluded that given the economic benefits generated, both the tangible and intangible benefits, the sector’s contribution to the Hong Kong’s economy should be greater than what the GDP figures may have suggested (Economic Analysis and Business Facilitation Unit HKSAR, 2008).

4.4. Human Capital Flow The movement of people was straightly controlled by the two governments, but the restriction has been loosened after year 2003. The Hong Kong government has also launched some immigrant schemes in order to attract professional and talents from the Mainland. The means of flow between Hong Kong and China include new immigrant flow, labour flow and visitors’ flow, they all exert a significant impact on the economy.

4.4.1. New Immigrant

One-Way Permit SchemeSince 1982, a one-way permit scheme had launched and allowed almost one million (as of 2007) Chinese residents living in Hong Kong. Under the scheme, there are 150 quotas for new migrants from Mainland daily, thus, there are around 55,000 new migrants annually. From year 1997 to 2009, there were around 642,000 migrated to Hong Kong for the reason of family unity (Graph 4.4.1.1.). Among the new immigrants 46% aged 18-65 while the remaining 54% were housewives and students. (Economic Analysis and Business Facilitation Unit HKSAR, 2007). Only half of them belong to the working group, nevertheless these new immigrants rejuvenate Hong Kong population as Hong Kong is now suffering from ageing population problem and

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having new immigrants will have a positive impact on the growth in the economy in long term. According to a report of the Task Force on population policy in 2003 (cited in Lau et al., 2004), these new immigrant contributed to around 30% growth of the labour force between 1999 to 2001. Thus, we can see that the new immigrants are important as an extra workforce in the labour market. Even though they may of low skill, they could take up the occupation in the low skilled markets which previously do not taken up by the local people.

Sung and Wong (2000) calculated that immigration from China lowered the GDP growth by 1% per year of Hong Kong in the mid 1990s due to low skilled endowment of these immigrants. However, the birth rate of Hong Kong is fairly low compared to other developed region in Asia, the average annual growth birth rate is only 0.4% by 2006 which is lower than the world’s average of 1.2% (Online World Department Indicator from World Bank Database). Thus, it may be easier to correct for skill insufficiency rather than to induce births to rejuvenate an aging population (Sung 2004).

Immigrant SchemeThe objectives of these schemes mainly focus on attracting talents and professionals from China in order to maintain the competitiveness of Hong Kong. The power of approval of these schemes is in the hand of Immigration Department of the Hong Kong government.

Capital Investment Entrant SchemeThe scheme was implemented on 27th October 2003. The objective of the scheme is to facilitate the entry for residence by capital investment entrants (the entrant), i.e. persons who make capital investment in Hong Kong but would not be engaged in the running of any business here. The entrant is allowed to make his choice of investments amongst permissible assets such as property, securities (Immigrant Department HKSAR). Up to March 2011, formal approval was granted to 7,942 Chinese nationals out of 9,708 total applicants. The amount of investments made under the scheme totaled HK$ 6.9 billion. The breakdown of investment classes in formal approval cases (as at 31-3-2011) are 34% on real estate and 66% on specified financial assets. This scheme brings in more new fund to the economy and support the growth in property and financial services industry.

Admission Scheme for Mainland Talents and ProfessionalsThis scheme was implemented on 15th July 2003. According to the information by

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Immigrant Department of HKSAR, the objective of the Scheme is to attract qualified Mainland talents and professionals to work in Hong Kong in order to meet local manpower needs and enhance Hong Kong's competitiveness in the globalised market. The Mainland talents and professionals must possess skills and knowledge not readily available or in shortage locally. As at the end of 2009, 33,488 Mainland talent and professionals were admitted under the scheme. These talents and professional provide new working forces on specified industry such as in the arts, culture and sports sectors. These new labour capital is important to rise the competitiveness of Hong Kong and sustain Hong Kong as a world city in the long turn.

Baby Boom From China There is increasing number of Chinese family giving birth in Hong Kong. Since 2001, a total of 139,863 babies were born by non-local resident of Hong Kong (Graph 4.4.1.2.) In 2010, over 37% babies (32,653) born were from Chinese family compared to 620 babies in 2001 with the average annual growth rate of 45.8%. Under the Basic Law in Hong Kong, these babies could be granted a permanent residentship in Hong Kong and enjoy all the benefits provided by governments same as the Hong Kong people such as twelve years-free education, medical benefits, public housing, social security assistance etc. This new population can improve the birth rate in Hong Kong and in long term, alleviating the effect of ageing population problem brought by low birth rates.

4.4.2. Chinese VisitorsBesides increasing number of Chinese migrants, the number of visitors from China also surged. Compared to other region, the growth in tourism is higher than other regions. The average growth rate is around 1.3% while Hong Kong’s tourism growth rate reached 6% since 2003. It was mainly due to rapid increase in the number of Chinese visitors (Economic Analysis and Business Facilitation Unit HKSAR, 2005).

Tourism related industry is one of core sectors in Hong Kong’s economy. Its related industries include accommodation service, retail trade, food and beverage services and other related personal services. According to the yearbook of 2009, the total visitors to Hong Kong was 29.59 million while Chinese visitors was 17.96 million, equivalent to 60% of total visitors. It brought lots of tangible and intangible effects to the economy.

Numbers of Chinese VisitorsThe number of Chinese Visitors jumped from 2.2 million to 18million from 2000-

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2009. The proportion of Chinese Visitors also increased from 22% to 60% of total visitors (Hong Kong Yearbook,2010).

Graph 4.4.2.1. Total Visitors to Hong Kong from 1997-2009

Source: Hong Kong Yearbook 2000-2009

From the above graph, it can be seen that starting from year 2003, the number of Chinese visitors exceeded non-Chinese visitors to Hong Kong. When we divided the periods, the accumulated growth rate of Chinese Visitors was strong in past decade while the growth of non-Chinese visitors was only half of the Chinese visitors (Table 4.4.2.1.).

Table 4.4.2.1. Accumulative Growth Rate for Numbers of Visitors2000-2009 2000-2003 2003-2009

Chinese Visitors 374.3% 123.6% 112.1%Non- Chinese

Visitors25.5% -23.8% 64.6%

Total Visitors 126.6% 19% 90.5%Source: Hong Kong Yearbook 2000-2009

Table 4.4.2.2. Average Annual Growth Rate on Numbers of VisitorsAverage Annual Growth Rate

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Chinese Visitors 17.5%Non-Chinese Visitors 4.3%

Total Visitors 10.2%Source: Hong Kong Yearbook 2000-2009The growth rate of Chinese visitors was quite strong in the past decade. The average annual growth rate is of Chinese visitors was 17.5% compared to Non-Chinese visitors of 4.3%. The important of Chinese visitors has been increasing as its share to the total visitors also kept rising. The growing trend on the numbers of Chinese and non-Chinese visitors has been reversed in the past decade. The percentage share of Chinese visitors rose from 29% to 60% showing that Chinese visitors have become relatively more important in tourism industry in Hong Kong(Graph 4.4.2.2.).

Graph 4.4.2.2. Percentage Share of Chinese and Non-Chinese visitors

Source: Hong Kong Yearbook 2000-2009

Individual Visit Scheme (IVS),The Chinese Visitors kept increasing due to the implementation of a new visitors scheme under CEPA and implemented in 2004. Under the Individual Visit Scheme (IVS), it allows residents four Guangdong cities (Dongguan, Zhongshan, Jiangmen, Foshan) to visit Hong Kong in their individual capacity. The coverage of the Scheme has expanded to 49 Mainland cities since implementation, including all 21 cities in

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Guangdong province , Beijing ,Shanghai ,Tianjin , Chongqing etc. Under this Scheme, around 270 million Mainland residents in the 49 cities with permanent household registration are eligible to apply for the relevant exit endorsement from the relevant Mainland authorities (Immigration Department HKSAR). Before having this scheme, Chinese residents can only visit Hong Kong by applying for commercial visa or joining group tourism. Thus, the IVS further enhanced the human flow from China to Hong Kong.

The number of visits in form of IVS increased from 4.26 million in 2004 to 10.59 million in 2009. The average annual growth rate was around 26%. The ratio of IVS to the total number of Chinese visitors soared from 35% to almost 60%. This shows that the share of IVS has been getting more important to the total Chinese visitors to Hong Kong. This new visitors’ flow create a high demand for consumption market in Hong Kong. According to a search, the average spending of IVS was around HK$ 2,185 per capita per day in 2005(Economic Analysis and Business Facilitation Unit, 2006). The spending were mainly on luxury products, clothing, cosmetics products and skincare products.

In order to capture this big tourism market, the tourism related industries have been expanding in terms of employment. The IVS scheme created HK$ 58 billion extra spending and 43,000 job opportunities from 2004 to 2008(Hong Kong Economic Yearbook, 2010). This snowball effect has been influential. According to a study, the IVS raised GDP in 2004 for 0.36%, which was around HK$4.5 billion (Economic Analysis and Business Facilitation Unit, 2005). In that year, the scheme created extra 16,600 job opportunities in tourism-related industries mainly in retail industry and food and beverages services and personal service. While in 2009, it brought in HK$ 16 billion value added and created extra 50,300 job opportunities. The effect of IVS keeps increasing (Trade and Industry Department, 2010).

Chinese Visitors’ SpendingGraph 4.4.2.3. Percentage Share of Total Visitors’ Expense

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Source: Hong Kong Yearbook 2000-2009

The effect of inbound tourism are more difficult to measure as it comprises a range of economy activities straddling different industries e.g. retail trade, food and beverage services, transport, accommodation services and personal services. In this session, I look at the value added brought and give some evidences of reputable retail companies that benefit from the Chinese visitors.

Since the handover, the exchange rate of Chinese Renminbi(RMB) has been appreciating against Hong Kong Dollar by 17.7%.5 The real purchasing power of the Chinese Visitors actually increased. In 2000, the total expense of Chinese visitors only contributed to 32% of total visitors spending. But in 2009, the share of expenses soared to almost 70% of total spending, which was equivalent to HK$ 68.6billion, at an average annual rate of 18.4% (Graph 4.4.2.4). Chinese Visitors become the major source of earnings in tourism in recent decade. The share of expenditure in Hong Kong’s total retail sales value also rose from 9.7% in 2002 to 15.3% in 2006 (Economic Analysis and Business Facilitation Unit, 2008).

The spending pattern of the Chinese visitors is mainly on shopping (77%), 10% on food and beverage, 10% on accommodation and 9% on transport. For the shopping categories, they spend on luxury goods such as watches, jewelry, beauty products and medicine for its quality assurance (Economic Analysis and Business Facilitation Unit,

5 RMB rises from RMB107 per HK$100 in 1997 to RMB 88.16 per HK$100 in 2009. Source: Census and Statistics Department of HKSAR

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2006). To conclude, the increasing number of visits and the substantial increase on their spending has been benefited to the tourism-related industry especially to the retail sector.

Retail SectorAs Chinese visitors spend 77% of their expenses in shopping, it can be expected that the impact to retail sector is more intense compared to other tourism-related sectors. Retail sector is one of the largest service industries in Hong Kong. In 2007, the number of establishments in the retail trade industry was about 57 000, employing 289 000 persons or about 8.3% of Hong Kong’s total employment. In terms of economic contribution, the retail trade directly generated $37.6 billion of value added in 2006, which equaled to 2.6% of the GDP of Hong Kong. It is also an important source of employment for the local workforce as this sector is highly labour intensive. According to a report from HKSAR, retail business grew rapidly over the past several years reaching $247.7 billion in 2007 with an annual average growth rate of 9.4% in value terms or 7.8% in volume terms during 2003 to 2007. The “China factor” was the major contributor (Economic Analysis and Business Facilitation Unit, 2008).

Examples of Local Retail Company The prime source of revenue of some retail companies such as Chow Sang Sang Holdings International Limited and Luk Fook Holdings (International) Limited comes from Chinese visitors. Both companies are notable listed jewelry companies in Hong Kong, according to their annual report in 2009, the total sales of Chow Sang Sang reached HK$8.3 billion. 33% of the sales were from branches in China, 28% were from Mainland visitors in Hong Kong. That mean more than 60% sales were from Chinese visitors directly and indirectly. While for Lok Fook Jewelry, Mainland visitors contributed to over 60% of total sales last year.

Bonjour Beauty Limited, another famous beauty and health care listed company in Hong Kong benefit a lot from Chinese Visitors. Its executive director, Mr. Chan expected that the percentage share of sales of Chinese visitors increase from existing 35% to 50% in coming years. He also pointed out that the total sales from Chinese visitors was five times higher than local consumer with average of HK$ 500-600 (Oriental Daily, 2010 September 15). As the share of Chinese Visitors and their spending has growing in the Tourism Industry, they play an influential role in the Tourism Industry in Hong Kong’s economy.

From the above analysis, we can see the people flow between Hong Kong and China

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is more intense in the last decade. The rising numbers of Chinese visitors has helped to sustain the tourism industry in Hong Kong as seen in Table 4.2.2.3. & Table 4.2.2.5. , the value added and employment rate went up 75.8% and 38.3% respectively from 2003 to 2009. The interaction was deepened with the implementation of the Individual Visit Scheme in 2003 which was an important driving force to the retail sector. These Chinese factors make the prospect of the retail sectors and tourism-related industries remain promising.

Other ImpactOn Specific IndustryThere are some induced effects by the increase of Chinese flow. As the rise in visits induce more consumption and investment in the economy, the consumption pattern of local market changed to external-oriented. Chinese Visitors can come to Hong Kong with lesser control since 2004. They regard Hong Kong more than a tourism centre but also an investment centre as Hong Kong has a sound property right and legal system. Since the handover, there has a trend for Hong Kong people to purchase properties in Mainland, especially in Guangdong Province as second homes. (Sung, 2004) This scenario is revered. Nowadays, many Mainlanders are getting wealthier and come to Hong Kong to purchase property as second homes or for investment purpose. In April 2011, there was a new property sale in Hong Kong with over 30% of the buyers being non-local Chinese. As pointed out by Cheung, the member of Executive Council of Hong Kong, there was a strong demand on property for non-local Chinese in Hong Kong and the property market was becoming external-oriented (Ming Pao News, 2011 May 15).

Besides, banking and investment consultant companies are also benefit from the flow. Sung (2004) pointed out that the contribution of IVS goes far beyond tourism as IVS improve access for Hong Kong’s service industries to the Chinese consumption market. “IVS lower the transaction cost of business between Hong Kong and China. It is more convenient for Mainlander to conduct business in Hong Kong such as to open security accounts for trading of securities, to search for investment property or to undergo medical operations.”

The increasing numbers of Chinese Visitors enhance the flow of information as well. The Chinese visitors could be more familiar with the brands in Hong Kong. This could help the brands in Hong Kong building up their imagines in China and thus boosting their sales, especially in Guangdong Province as its residents share same language with Hong Kong. The effect on the information flow could be intensified.

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Tourism and other related industry is likely to be benefited from the integration with China.

4.5. Regression Analysis In the previous few chapters, I have shown that the flow of capital and flow of people of China have had a positive impact on the value added and employment on the Financial Services Industry and Tourism Industry respectively. In this section, an attempt is made to assess the impact of integration by using regression analysis.

Four regressions would be carried out to see if the flow from China would have any impact on Hong Kong’s economy. I will measures the effect of capital flow and visitors’ flow between Hong Kong and China by using employment and value added as the dependent variables of Financial Services and Tourism Industry respectively.

4.5.1. Data Collection & LimitationAll the data are from governmental resources. The data period is from 2000-2009 as it is the scope of my study and the integration has been deepened since the last decade. The data was collected from several organizations, namely Census and Statistics Department of Hong Kong Special Administrative Region, Hong Kong Stock Exchange. Data are converted to constant price of year 2009 if necessary and being logged. A potential limitation of the regression would be that the results might have distortions due to limited observations. More observations would improve the accuracy of the model. Even though limitation in observation would affect the regression result, the figures could give us some insights into the relation between variables.

4.5.2. Financial Services IndustryIn this part, I will examine how the movement of capital affects the income and employment of Financial Services. Based on the previous discussion, I assume that that the Chinese stocks and their fund raising activities would have a positive impact to the value added on the Financial Services Industry. Using the Ordinary Least Square (OLS) method, the following regression model is being estimated:

Value AddedValue Added = α + β1 IPO of Chinese Firms + β2 Market Capitalization of Chinese stocks + β3 Turnover of Chinese stocks + εWhere ε is a random error (i.i.d.)

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Here is the regression result: Dependent Variable Independent Variable Coefficient P value

Value Added IPO of Chinese Firms 0.032071 0.589728Value Added Market Capitalization of

Chinese stocks0.203796 0.165023

Value Added Turnover of Chinese stocks

-0.00357 0.983668

R2: 0.876465Adjusted R2: 0.814697Significant F: 0.003928

As the result of this analysis has a very high P-value on all variables, thus I take out the one with highest P-value, i.e. the market capitalization of Chinese stocks. The result is as below:

Dependent Variable Independent Variable Coefficient P valueValue Added IPO of Chinese Firms 0.031632 0.535442Value Added Turnover of Chinese

stocks0.201187 0.001114

R2: 0.876455Adjusted R2: 0.841157Significant F: 0.000663

Both R2 and adjusted R2 values of 0.876455 and 0.841157 respectively both indicated that there is a high degree of goodness of fit of the model. It means over 80% of variance in the dependent variable can be explained by this model. The significant F is at statistical level (<0.05) means that the probability of these results occurring by chance was quite less, thus can reject the null hypothesis.

For the individual coefficients, only the “Turnover of Chinese Stocks” has a positive impact on the value added in the industry. The share of Chinese stocks on turn over is at very high statistical level (<0.05) and with a positive coefficient with the value added in the Financial Service Industry. Thus, we can conclude that the turn over of Chinese firms has a positive impact on the value added to the Financial Service Industry. While for the IPO by Chinese firms, the P-value is very high thus accepting the null hypothesis. This might be explained that the value added generated by IPO is non-recurrent, thus the value added to the industry is not obvious but as discussed

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earlier, IPO has a spillover effect on the economy that stimulate additional consumption and investment spending to Hong Kong which is difficult to quantify (Bauhinia Foundation Research Centre, 2008).

EmploymentBased on the previous discussion, I assume that that the Chinese stocks and their fund raising activities would have a positive impact to the employment on the Financial Service Industry. Using the Ordinary Least Square (OLS) method, the following regression model is being estimated:

Employment = α + β1 IPO of Chinese Firms + β2 Market Capitalization of Chinese stocks + β3 Turnover of Chinese stocks + ε Where ε is a random error (i.i.d.)

Here is the regression result: Dependent Variable Independent Variable Coefficient P value

Employment IPO of Chinese Firms -0.00921 0.758558Employment Market Capitalization of

Chinese stocks0.0064719 0.984932

Employment Turnover of Chinese stocks

0.001675 0.36129

R2: 0.693178Adjusted R2: 0.539767Significant F: 0.055399

As the result of this analysis has a high F-value, thus I take out one variable with highest P-value, i.e. the market capitalization of Chinese stocks. Here is the result:

Dependent Variable Independent Variable Coefficient P valueEmployment IPO of Chinese Firms -0.009 0.72592Employment Turnover of Chinese

stocks0.065942 0.01107

R2: 0.693158Adjusted R2: 0.605489Significant F: 0.016003

Both R2 and adjusted R2 values of 0.693158 and 0.605489 respectively both indicated

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that there is a reasonable degree of goodness of fit of the model. It means over 60% of variance in the dependent variable can be explained by this model. The significant F is at statistical level (<0.05) means that the probability of these results occurring by change was quite less, thus can reject the null hypotheses.

For the individual coefficients, “IPO of Chinese Firms” gets a negative coefficient and its P-value is very high, thus accepting the hull hypothesis. This could be explained that the effect of IPO may be a one-off effect, thus its impact on employment may not be so obvious. Besides, more IPOs from China also indicate that there are more Chinese firms listed in Hong Kong, hence it may have a persistence effect on the market turnover in later time instead. The turnover of Chinese stocks is at very high statistical level (<0.05) and with a positive coefficient with the employment change in the industry. Therefore, we can conclude that there is a significant relationship presented between the change of employment and turnover of Chinese stocks.

To conclude, from the above regression analysis, we can see that turnover of Chinese stocks has a positive impact on the value added and employment on the Financial Services Industry. While the regression results do not conform the positive effect of IPO on the industry, it could be explained that the impacts of IPO might be more intangible and difficult to quantify, thus the result may not be that obvious.

4.5.3. Tourism IndustryIn this part, I will examine how the movement of people affects the income and employment on Tourism Industry. Based on the discussion, I assume that that the number of Chinese visitors and their spending have a positive impact to the value added on the Tourism Industry. Using the Ordinary Least Square (OLS) method, the following regression model is being estimated:

Value AddedValue Added = α + β1 China Visitors + β2 Chinese Visitors’ Spending + ε Where ε is a random error (i.i.d.)

Here is the regression result: Dependent Variable Independent Variable Coefficient P value

Value Added Chinese Visitors’ Spending

0.638593 0.023897

Value Added Chinese Visitors -0.08186 0.566403

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R2 : 0.803129Adjusted R2 : 0.74688Significant F: 0.003386

The R2 and adjusted R2 are well explained the model with high statistical significant (<0.01). For Individual coefficient, Chinese Visitors’ spending is quite high and the P-value is at statistical level (<0.05) which rejects the null hypothesis. The coefficient is at 0.638593 indicating that one unit growth in Chinese Visitors’ spending would cause a 0.64 growth in value added in Tourism Industry. This result conforms our previous discussion that Chinese Visitors’ spending would have positive impact to the value added to the Tourism Industry. While for Chinese visitors, it has a negative correlation with the value added in the industry but as its P-value is high that it accepts the null hypothesis. The chance of occurring by chance is high.

EmploymentBased on the discussion, I assume that that the number of Chinese visitors and their spending have a positive impact on the employment on the Tourism Industry, thus the following equation is being estimated:

Employment = α + β1 China Visitors + β2 Chinese Visitors’ Spending + ε Where ε is a random error (i.i.d.)

Here is the regression result: Dependent Variable Independent Variable Coefficient P value

Employment Chinese Visitors’ Spending

0.25565 0.000644

Employment Chinese Visitors 0.202285 0.002767R2 : 0.986874Adjusted R2 : 0.983123Significant F: 0.00000026

Both R2 and adjusted R2 values of 0.986874 and 0.983123 respectively both indicated that there is a high degree of goodness of fit of the model. Over 90% of variance in the dependent variable can be explained by this model. The significant F is very closed to Zero (0.00000026) means that the probability of these results occurring by change was very less, thus can reject the null hypothesis. Therefore, we can conclude that there is a significant relationship presented between the rate of employment and

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rate of Chinese visitors and their spending. Both coefficients of the variables are positively correlated with the change of employment, that means one unit change in Chinese Visitors and their spending will cause 0.21 and 0.26 increase in employment respectively. Both P-value of variables are at very high significant level (Chinese Visitors < 0.01; Chinese Visitors’ Spending <0.001), thus rejecting the null hypothesis.

To conclude, from the above regression analysis, we can see that Chinese visitors’ spending have a positive impact on the value added and employment on the Tourism Industry.

Chapter 5 : Possible Negative Externalities & Obstacle on integration Previous session examine the interaction between Hong Kong and China and the economic impact of the interaction. At the same time, the rising flow has created some negative externalities in Hong Kong’s economy intangibly.

5.1. Capital Flow As Hong Kong is an international financial centre, it is a capital-parking hub for other countries. Capital flows constitute a potential source of financial sector and result in excessive credit growth during booms and a credit crunch during a recession (Leigh, 2004). Flooding with capital would increase the volatility of Hong Kong stock market and thus to the economy. With increasing importance of Chinese-affiliated stocks to Hong Kong financial market, the sentiment of investors are more vulnerable to the China macroeconomic condition especially to the policies announced by the Chinese government such as tightening the monetary policy. As Hong Kong becomes more integrated with China, the potential spillover effects of macroeconomic fluctuations of China on Hong Kong economy could increase (Leigh, 2004). This impact has become more obvious to the financial markets in the past decade.

5.2. People FlowThe increase of people flow creates some negative impacts to the Hong Kong economy. Flow of people creates uncertainties, as human behaviour is hard to predicted and assumed. Some issues have appeared and the most attended issue is completing resources in Hong Kong.

5.2.1. Competition for Resources

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Government ServicesThere are an increasing number of Chinese families giving birth in Hong Kong. In 2010, over half of the baby born in Hong Kong were from Chinese family and they were entitled to permanent residence in Hong Kong and enjoy all welfares provided by the government. As these babies are not regularly reside in Hong Kong, it is difficult to project the demand for education, medical, housing needs in the future years, and thus creating a big problem in resources planning in the long term. When all of them flow to Hong Kong in the age of school attachment, this would create enormous pressure on every aspect in the society. Even now, many Hong Kong pregnant women complaint about having insufficient medial check up and could not reserve a bed in hospitals and it is a common phenomenon in Hong Kong now. More than that, public hospital doctors and nurses lodged complaint of insufficient manpower to perform their job duties especially on pregnant woman, infant care service and infant Intensive Care Unit Service to the government in April 2011. The standard of medical service to local resident is greatly infringed due to limited resources but increasing external demand.

Consumption MarketAs the exchange rate of Chinese Renminbi(RMB) has been kept appreciating , it increases the real purchasing power of Chinese visitors. Many Chinese visitors are fond of coming to Hong Kong to shop so as to enjoy a discount of almost 18 % off on every spending item. They do not only shop luxurious products e.g. watches, jewelry but also shop some daily necessities such as infant formula, shampoo. Hence, the demand on these necessities surged and causes a shortage problem. Besides, due to products price difference between China and Hong Kong, grey market appears near the boundary. It further boosts up the demand on the consumer products. This has already caused a great disturbance to the residents in Hong Kong. It is not uncommon that Hong Kong’s mother fails to buy infant formula for their children due to shortage.

Besides daily necessities, some Chinese residents compete with local people for property housing. Many affluent Mainlanders come to Hong Kong to purchase property as second homes or for investment purpose. In last decade, it is found that more and more Chinese purchase properties in Hong Kong. Cheung (2011) expressed that the price of property has increased faster than the purchasing power of local Hong Kong people. The property prices in Hong Kong kept rising due to a huge demand from the Chinese people and this resulted in a structural problem to the property market in Hong Kong. As such, local residents find themselves in great difficulty to

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purchase properties in Hong Kong (Ming Pao News, 2011 May 15).

5.2.2. Crime The Individual Visit Scheme (IVS) does bring a huge influx of Chinese visitors to Hong Kong. But at the same time, the flow of people brings negative impact. The IVS scheme opens a gateway for theft, prostitution, illegal workers and mendicancy which creating serious social problems.

5.2.3. Public Health The more the movement of people, it brings the hygiene problem as well. The evidence of SARS was the good example. The spread of SARS from Guangdong to Hong Kong had highlighted the risks and costs of integration. The public health problem may have devastating impact on the economy, and such costs may be very large and difficult to be quantified. Secondly, the hygiene in some public areas is affected by Chinese visitors.

5.3. Obstacle and Challenge on integrationThough there is increasingly integrated with Hong Kong and China, the linkage has been hindered by some factors and these factors are quite fundamental which limit the speed for further integration.

5.3.1. Marco Level

PoliticalPolitics is always the obstacle for integration. This explains why before returning to China, the integration was on local level. Even after the handover, the integration between two regions had not been speed up as people expected. In order to avoid people’s concern on the principle of “One Country Two System”, the relationship between Hong Kong and China in national level was not really close in the first few year of return (So, 2011). Not until the SARS outbreak, both regions started to resume a very tight and close relationship. Many scholars pointed out that Hong Kong had been lagging behind on the integration with China compared to other regions. In 2009, political issue aroused regarding the building of the railway connecting Guangdong and rest of China. Over thousands opponent protested and surrounded the Legislative Council of Hong Kong to support lawmakers to object the proposal. The reason behind was that people were afraid Hong Kong was losing its autonomy and “Two system” would become more “ One Country”. Finally the proposal was delayed for few months in order to get it passed for funding. This political concern is still an

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obstacle for the further integration.

Different CultureThough Hong Kong is close to Mainland China and used to be a part of China, they are of different cultures. Being ruled by British government for 99 years, education background, knowledge and scope is different. Culture shapes people behaviour which result a wide cultural gap. In recent years, there is increasing discontented towards Chinese people regarding the hygiene awareness and competition for resources in Hong Kong. Such feeling has turned into an identity argument, or even animosity. On the internet, there are full of arguments emphasizing the difference between Chinese people and Hong Kong people. The conflict between the people of two regions has been getting more obvious. This has hindered the rising integration as the discontented feeling would turn into some political conflicts.

5.3.2. Micro LevelInternally, there are few weaknesses of Hong Kong that limit further integration.

Lack of human capital to meet the rising demandRising integration caused rapid structural change in Hong Kong and transformed Hong Kong from a low valued manufacturing centre to high value service centre. Therefore structural change required lots of human capital to cater for the shift. According to a government’s 2001 manpower projection report, it was estimated that by 2007, there was a shortage of 99,000 workforce with higher education and a surplus of about a quarter of million people with a secondary –school education or less (cited in Lau et al., 2004). The shortage of high skilled workforce at present and in coming decade would hinder the structural transformation in Hong Kong and its competitiveness.

Incapable to meet the rising demand To enhance the integration, it is necessary to ensure the capacity of the flow on goods, capital, people and information. Fung (2008) pointed out that Hong Kong should improve the hardware to enhance the flow. However, the capacity of this hardware such as the capacity of road and airport runway is closed to its maximum. The road connection infrastructure with Guangdong Province is insufficient. The capacity of the airport runway is estimated to be saturated in 2014. But so far, the building of a new runway has not been discussed and arranged. Besides, Hong Kong is also lack of berthing facility for large cruise. This would pose big constraint to the flow of goods and visitors in coming years. In order to retain the position as a service and logistics

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hub, Hong Kong has to maintain its capacity, leading in skills and service quality.

5.3.3. Cope with the Challenge As discussed, the obstacle in macro level hinder the integration with China is the political reason and the cultural difference. These problems rooted with communication. Hong Kong people are afraid to be integrated with China as they do not have sufficient confidence to the Chinese government. They are afraid that being integrated will lose their autonomy. For the culture different, it takes time to accept and respect others’ culture. It might take a long time to break the tight relationship. More mutual understand and commutation is needed to improve the relationship. Seeking the common grounds of the two regions and exploring all possibilities to seek multilateral prosperity and stability is the key to be succeed in the integration process (China Daily, 2005 March 30). The Hong Kong government can also help to reduce the gap by minimizing the negative impacts brought by Chinese People.

In micro level, Hong Kong should well aware to tackle its weakness and make a defined strategic planning for its long-term development. For hardware, it should consider to enhance the capacity of all the logistics hub of land, air and sea so as to facilitate the flow and maintain its strength on trading and logistics. For software, government should provide sufficient support to family to encourage birth. These support should be more practical such as having a throughout pregnancy support in hospital, ensuring having sufficient resources to service local pregnant woman, giving incentive on birth to solve the problem of low birth rate. To ensure the supply of high skilled workforce in coming year, the government can consider increasing the number of university attendant on some specific subjects that the economy needed and demanded. These suggestions require the government to have a detailed planning and determined action so as to maintain the competitiveness of Hong Kong.

Chapter 6 : Conclusion & Looking Ahead

6.1. ConclusionHong Kong and China has its long historical tie. However, the economic linkage of the two regions was blocked in 1950s because of China’s adoption of isolation policy and subsequent embargo. The linkage was restored in late 1970s due to the economic reform and door opening of China. Many studies has already assessed that this integration has been beneficial to Hong Kong in a way of transforming Hong Kong as a commercial hub and causing rapid structural change in later year. In the early stage, the integration was more of a one-way flow and mainly initiated by the private sector

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in Hong Kong. They brought new capital and human capital to China for development. In the reciprocal, China’s flow to Hong Kong on capital and people was constrained. This situation was reversed when Hong Kong was handed over to China in 1997. The interaction between them become more frequent but the milestone was set in 2004 with the promulgation of the CEPA arrangement.

As the first institutional arrange was signed, CEPA gave a new direction on the relationship, and flow of capital in the form of equity and fund raising was encouraged to Hong Kong from China. The flow of people in forms of immigrant and visitors also surged by relaxation of immigration policy leading to signidicant impact to Hong Kong’s economy. This thesis shed light on how the flow affects the two key industries ( Financial Services Industry and Tourism Industry) out of four due to their rapid growth and their growing trend in share on value added and employment. As assessed, capital flow from China has extended the depth and horizon of the Hong Kong Stock Market, thus attracting new investment from foreign countries which further consolidated Hong Kong as an international financial centre. The financial market has been expanding and the employment share of the service industry increased steadily. For people flow, mainland immigrants reinforced the labour force while visitors brought huge sales and revenue to tourism-related industries such as hotel, catering and retail sales sector. The valued added and employment of these sectors has been expanded rapidly as tourism is a highly labour intensive industry. A further assessment by using regression analysis has been performed in this thesis and the results conform that “China factor has a positive impact on both sectors”.

Nothing is perfect. The increasing flow also creates some negative externalities to Hong Kong economy and society. The stock market is getting more volatile due to flood with parking capital. Hong Kong economy is more vulnerable to the China market especially to the policy announced by the Chinese government. Social problems like crime, mendicancy and public health also intensify with influx of Chinese visitors which exert negative impacts to Hong Kong Economy. Due to scarce resources in Hong Kong, local residents also have to compete for different resources with the Chinese visitors which lowering the living condition of local Hong Kong residents. All these further widen the cultural gap between China and Hong Kong, which in turn hindered further progression of integration. Voices of anti-integration stand in Legislative Council and have turned into some political issues. Communication should be the way to reduce the suspect and rebuild the trust between two regions. But it would take a long way. The integration is also obstructed by the weakness of Hong Kong, i.e. lacking sufficient human capital and capacity to

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facilitate the flow. Uprising Chinese cities such as Shanghai and Guangzhou has been competing with Hong Kong in many aspects now, it is necessary for Hong Kong to formulate and implement defined long-term strategy so as to maintain its strength on financial service and tourism industries.

6.2. Looking AheadFrom the pervious discussion, it could be seen that the cooperation and interaction would be increasing in terms of the flow of capital and people in the near future. At the moment China and Hong Kong possess different strength in economy. The integration would be benefit from difference in comparative advantage and in different development path of China and Hong Kong. To tighten this cooperation, it is necessary for Hong Kong to advance further and keep its leading position in some sectors in the economy. One of the most competitive industries is the financial services industry and professional service industry.

6.2.1. Strength Hong Kong is the freest economy in the world, a position it has held since 1995 accordng to The Heritage Foundation(Hong Kong Yearbook, 2009). Likewise, the Fraser Institute of Canada has consistently ranked Hong Kong as the world’s freest economy as well. As an international business hub, Hong Kong has a good institutional system with rule of law, a sound legal framework and an independent and efficient judiciary, a simple tax system with low tax rates, free flow of capital and information, mature financial market and sound banking system and a sophisticated supply chain. The free flow of information also makes Hong Kong as a coordination centre to the world.

Hong Kong also has substantial foreign exchange reserves, a fully convertible and stable currency, prudent fiscal management that keeps Hong Kong as the most competitive city in the world. These virtue should be uphold and continued be practiced. Hong Kong still keeps its strength on free flow of currency. Because of its linked exchange rate system with US Dollar, Hong Kong is a parking pool for capital if there were any financial crisis. Another strength of Hong Kong is its elite human capital especially in the banking and financial industry. Employees are highly creative, innovative and professional. Hong Kong also process high standard on research and development.

6.2.2. Threat China is still on the road of liberalization and its market is still straightly controlled.

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Renminbi is not fully convertible and floated in the capital market. But with the increasing liberalization, Hong Kong will lose its role as the connection between China and the world. Foreign enterprises would invest directly in the cities in China such as Shanghai and Guangzhou for their easy accessibility to the rest of China and its consumer market. For tourism, Hong Kong has been one of the most popular destinations for Mainland visitors. Yet, in recent year, its attractiveness has been dimmed by other uprising cities which have been building lots of new tourist spots, such as Shanghai is going to build the Disneyland while Singapore has built two casinos. Recently, a tax-free shopping zone has been set up in Hainan Province for the Mainlander. It is foreseeable that Hong Kong is going to face keen competition from other countries and within the cities in China as well.

Integration is a global trend. Hong Kong should seize its special privilege granted by the Chinese government for further development instead of isolating herself. In this thesis, only the part on the benefit and costs to Hong Kong of rising integration has been discussed. A further research on the reciprocal impact is worthwhile.

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Reference

Ash, R.F. and Kueh, Y.Y. (1993). Economic integration within Grater China: Trade and Investment Flows between China, Hong Kong and Taiwan. The China Quarterly No. 136 P. 711-745

Balassa, B. (1962). The theory of economic integration. London: George Allen & Unwin Limited.

Bonjour cooperates with Ctrip attracting Chinese Visitors. (2010, September 15). Oriental Daily. Retrieved from http://orientaldaily.on.cc/cnt/finance/20100915/00271_003.html

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Appendices

Graph 1.1. Gross Domestic Product of Hong Kong Since 1997

Souce: Census and Statistics Department HKSAR

Graph 1.2. Gross Domestic Product of Hong Kong Since 1997

Souce: World Bank Database, Year 2000PPP

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Graph 2.3.3. Hong Kong Heng Seng Index Since 1986

Source : from Finance yahoo.com

Graph 4.1. Gross Domestic Product by Board Economic Sector in 1988 and 2008

Source: Hong Kong Year Book 2009

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Graph 4.2. Employment by Broad Economic Sector in 19888 and 2009

Source: Hong Kong Year Book 2009

Graph 4.2.1.1 Percentage Share in GDP of Four Key Industries in Hong Kong Since 2000

Souce: Census and Statistics Department HKSAR

Graph 4.2.1.2 Percentage Share in Employment of Four Key Industries in Hong Kong Since

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2000

Souce: Census and Statistics Department HKSAR

Graph 4.3.1. 1. Total Direct Investment to Hong Kong 2000-2009

Souce: Census and Statistics Department HKSAR

Graph 4.3.2. Total Initial Public Offering raised from Chinese Enterprises 2000-2009

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Source: Hong Kong Stock Exchange

Graph 4.3.2.1 Percentage Share of Market Capitalization in the Main Board in Stock Exchange

Source: Hong Kong Stock Exchange

Graph 4.3.2.2 Percentage Share of Market Turnover in the Main Board in Stock Exchange

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Source: Hong Kong Stock Exchange

Graph 4.4.1.1. Number of Chinese Immigrants to Hong Kong Since 1997

Souce: Hong Kong Yearbook from 1997-2009

Graph 4.4.1.2. Number of Chinese Baby Born by Non-Local Hong Kong Residents Since

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2001

Souce: Souce: Census and Statistics Department HKSAR

Graph 4.4.2.4. Total Visitors’ Spending In Hong Kong

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Appendices -Regression Result

Financial Services Industry - Value Added Regression 1

Regression 2

Financial Services Industry - Employment

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Regression 3

Regression 4

Tourism Industry - Value Added

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Regression 5

Tourism Industry - EmploymentRegression 6

65