ECON 3350 Group Project
Industrial Upgrading in Guangdong Province in the 12th Five-
Year Plan Period:
Implications for Hong Kong
December 2011
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ECON 3350 Group Project
Group 2
Jimmy Lee
Alex Wai
Coco Huang
Calvin Li
Contents
I. Introduction
II. Situation of Low Value-added HK manufacturing Firms in Guangdong
III. HK Participation in High-end Manufacturing Industry Development
IV. HK Participation in High-end Service Industry Development
V. Development of Producer Services support
VI. Development of Environmental Industry
VII. Development of Innovation and R&D
VIII. Conclusion
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ECON 3350 Group Project
I. Introduction
In development economics, industrial upgrading (or structural transformation) is
vital when a country transitions into a higher level of development. Industrial
upgrading refers to a fundamental shift in industrial structure from low-end (or low
value-added) industries towards high-end (or high value-added) industries. As China
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now advances into a new stage of development, its recent 12th Five-Year Plan
highlights the importance of (fastened) industrial upgrading. Guangdong, as a leading
province in terms of economic development (indicators include GDP per capita), will
be one of the regions that bear the upgrading task. With geographical proximity and
traditional linkages, such transformation will bring enormous opportunities and
challenges to Hong Kong. This paper will therefore explore several areas which are
crucial in Hong Kong’s point of view.
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II. Situation of Low Value-added HK manufacturing Firms in Guangdong
Recently there are more than 60000 HK-owned factories in the PRD region.
A special feature of earlier development in Guangdong province is “three
processing and one compensation”(三来一补): to assemble with supplied parts, to
process with materials, samples and compensation trade. This model has led
Guangdong to a speedy and great development, yet left behind problems as the
economy now undergoes a structural transformation.
As a result of global financial crisis, every economy and every firm around the
globe has been facing a bad time. The worsening global market adversely affects
many businesses of these low value-added HK-owned firms in Guangdong province,
which highly affects their normal running. Financial shortage also leads to a retreat in
the investment in those firms, limiting their further development.
In the meantime, RMB appreciation and a change in China’s trade policy and
export compensation have added troubles to these firms. Since export income
occupies a big share in their total income, all these factors will definitely result in
shrinkage of foreign business and a loss of profit.
In addition to problems of global environment and China’s policy, the rising cost
in industry generates difficulties for these enterprises. Because of continuously
surging inflation in China in recent years, the cost of raw materials increases rapidly.
At the same time the nagging labor shortages and worker demands for higher wages
to help offset soaring food and property prices contribute a lot to the rise in
manufacturing costs. According to a news report, a lack of 10% to 30% in labor
commonly exists in firms in the PRD region. Besides, the minimum wage in
Guangdong province has been raised by 21.2% and 18.6% respectively in there two
years, squeezing more profits from this low value-added industry.
Troubles point to a dim future for the low value-added industry. The vice
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chairman of Hong Kong Industry Association predicted that 30% of the HK-owned
firms in Guangdong might be unable to survive this predicament.
Given this worrying trend, how can Hong Kong firms survive?
On the one hand, firms themselves should adapt to the market, adjust the
products’ structure and create new products to fulfill various needs of consumers.
Opening up new markets can also be a solution, and many firms have done so
already in South Africa. The vital and core method is to upgrade the development
model so as to change the industry from low value-added to high value-added.
On the other hand, the Hong Kong government should take actions
immediately. Policies to encourage domestic consumption will help firms to gain
more consumers and business. Technology funds set up by government which
originally only aim at promoting domestic factory should broaden its helping range
and offer assistance to factories from Hong Kong. Besides, reduction in unnecessary
fine will benefit firms in trouble a lot.
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III. HK Participation in High-end Manufacturing Industry Development
Developing high-end manufacturing industry will be one of the emphases in
industrial upgrading. Transition is implied as we consider the current dominance of
low-end manufacturing industry. As quality of products is emphasized, skilled labour
becomes significant. Nevertheless, investment is equally important as a factor for the
high-end development. Investment in capital enhances the firm’s capability and the
firm can also provide training to improve its output per worker.
Indeed, high-end manufacturing involves either utilization of a more
sophisticated form of technology or designation of unique products (ODM / OBM). In
both cases investment play a crucial role, either in the form of financial or human
capital. Hong Kong therefore can serve as a provider of these forms of capital with its
clear advantages. In terms of financial support, Hong Kong can continue its
traditional function as FDI contributor; in terms of human capital, Hong Kong has
experienced expertise in product design, brand management, marketing and
advertising, which are essential ingredients of ODM / OBM business. Beyond that,
Hong Kong has the innovation capacity to support technological development
(discussed in later section).
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ECON 3350 Group Project
Collaboration efforts have also been in progress at the government level. In
2005, the two governments jointly set up the Guangdong/Hong Kong Technology Co-
operation Funding Scheme, which aims to upgrade the technological level of industry
in the Greater Pearl River Delta region and help developing the high value-added
industries. The scheme also aims to develop links among universities, research
institutes and technology enterprises in the region. Since its establishment, R&D
projects valuing RMB $200 million have been launched. These have favored
development in information and communications technology, critical precision
manufacturing technology, medical biotechnology and medical device. The Hong
Kong government should utilize these existing links and explore more possible areas
of collaboration as to strengthen Hong Kong’s role in such development. It should be
noted that Guangdong does not necessarily rely on Hong Kong in developing high-
end industry. It has developed various kinds of support to local development in
technology and capital needed, for example, it has announced to spend RMB $10
billion on development of rising industries and enterprise building. It has also invited
foreign experts to develop high-tech products. Under such circumstances, Hong Kong
should avoid duplicating Guangdong’s key projects, but instead acting as a
complement to its development.
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IV. HK Participation in High-end Service Industry Development
A major aspect of industrial upgrading is the development of service (tertiary)
industry, which is high-end by nature. Since the 11th Five-Year Plan, increasing the
share of tertiary industry in GDP has been an objective of Guangdong. It has now
announced a new aim of 48% by 2015. This not only means increasing services in
quantity, but also broadening and sophisticating services.
Meanwhile, Hong Kong inarguably specializes in service industry (see table
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below). It has, on the one hand, a high-skilled and knowledgeable labour force, and
on the other hand, successful past experience of transitioning from manufacturing to
services.
The signing of CEPA was a benchmark in Hong Kong-Guangdong collaboration. It
has also provided opportunities for Hong Kong businessmen and experts to
participate in Guangdong’s development. For example, the GD/HK CEPA Services
Expert Group was set up under the Hong Kong/Guangdong Cooperation Joint
Conference. Under CEPA, companies in HK enjoy preferential treatment when setting
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up businesses in various service sectors in Mainland China, and it opens up huge
markets for HK’s goods and services. These service sectors include medical services,
distribution, banking, securities, tourism, and professionals like accounting. Most of
the service sectors mentioned under CEPA are the leading and well-developed
industries in Hong Kong.
Through the economic integration between Guangdong and HK, HK can expand
its market to Mainland China providing quality services, promoting the services
industry development in Guangdong, this is a win-win situation. It should be noted
that expanding service businesses is a necessity rather than merely an opportunity.
After all, the major problem that Hong Kong businesses face is the lack of space.
With urbanization and growth in income under advanced development of
Guangdong, Hong Kong can no longer serve only as a service hub locally and to
mainland tourists. It can now establish its businesses in the mainland directly and
engage in the enormous market. Early success has already been seen in the 11th Five-
Year Plan period. According to estimates, there are more than 100 000 HK companies
that have been introduced to the area and during 2004-2009, business receipts
obtained by HK’s services industry due to CEPA-related businesses are up to HK$61.6
billion.
V. Development of producer services support
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There is a reason to allocate an independent section to ‘producer services’, as
separated from ‘services’, since producer services are truly distinguished strengths of
Hong Kong. For instance, producer and professional services has officially been
regarded as one of the four pillar industries in Hong Kong.
The “front shop, back factories” (前店後廠) collaborative relationship has been
maintained between Hong Kong and Guangdong since the economic reforms in
1978. Utilizing the comparative advantage of legal system and international
experience, Hong Kong specializes in providing producer services to PRD, including
financial services, professional services, trade-related services and communication
and media services.
However, statistics revealed that Hong Kong’ function of “Front shop” declines
with keen competition from mainland firms arose in recent years. According to a
survey conducted in 2003, only 30% of local producer services providers considered
themselves to have competitive advantages in PRD. Confronting the industrial
upgrading occurs in Guangdong province, Hong Kong’s producer services industry is
now restructuring to face the challenges.
For instance, the development of Hong Kong maritime industry has slowed
down in the past two decades with competition from Shenzhen Yantian Port and
Shanghai Pudong Port. Hong Kong was the 1st world largest container port from
1999 to 2004, in terms of cargo throughout, suppressed by Shanghai in 2006. The
difference of cargo throughout between Hong Kong and Shenzhen has also largely
narrowed, from 10 million TEUs to less than 1 million TEU in 2009.
Instead of the traditional trade-related services like the logistic industry, Hong
Kong is now focusing more on the area of professional services to grape the new
opportunities created in PRD. This refers to our earlier discussion of professional
services marketing, design and brand management in the ‘high value-added
manufacturing section’.
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VI. Development of environmental industry
One initiative during the Five-Year Plan period is to reduce environmental
pollution and to pursue cleaner production process. This creates a new form of
market – the market for cleaner energy use. Since Hong Kong is a more developed
economy and has seen the need for cleaner energy earlier, it has a comparative
advantage in the environmental industry. Therefore, the Five-Year Plan period sees
growing demand for Hong Kong environmental products. According to the prediction
from Hong Kong Trade Development Council, the overall consumption of
environmental related products and services in Pearl River Delta will increase to
HKD$90 billion by 2018.
Studying Hong Kong’s position in the economic development in China, the
Greater Pearl River Delta Business Council indicated the possible development of our
environmental industry. For instance, Hong Kong’s professional services firms can
introduce foreign capital and technology to promote regional recycling industry and
achieve economies of scale. Our strengths in urban water treatment, energy saving in
buildings and environmental impact assessment technology services can assist
mainland’s corporation overcoming the obstacle of industrial upgrading.
Environmental consulting services providers can engage in projects of energy
efficiency and education for mainland cities to achieve the national target to reduce
carbon emission intensity.
Besides, Hong Kong has reached agreements with the Guangdong government
on various favorable policies, relaxing restrictions and limitations to allow local
professional firms to engage in the mainland environmental industry.
A highlight of collaboration efforts has been the “Cleaner Production
Partnership Programme”. It has been established between Hong Kong and
Guangdong since fiscal year 2008/09, in which funding and subsidies are provided for
Hong Kong invested corporations in Guangdong to pursue cleaner production. With
requirements to purchase products and services only from the registered
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Environmental Technology Service Providers, it creates opportunities for the local
environmental industry to develop its business in Guangdong. Moreover, Hong Kong
enterprises can now participate in Clean Development Mechanism (CDM) projects on
the mainland. As around one-third of CDM projects are carried out in Mainland
China, Hong Kong enterprises can explore new business opportunities in projects
with major technology transfer, like the development of renewable energy.
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VII. Development of Innovation and R&D
As stated in the 12th Five-Year Plan, the aim of China is to achieve quality
growth. The emphases of ‘innovation and R&D’ and a ‘knowledge-based economy’
follow this guidance naturally. This is particularly the case in Guangdong, which
strives to become a leading province in innovation capacity. Meanwhile, the Plan has
also mentioned the need to strengthen Hong Kong’s innovation capacity in business
and industries. In this section, we will analyze how Hong Kong’s existing assets can
help support innovation development in Guangdong, as well as the required
strategies and improvements.
Firstly, we identify 3 possible functions of Hong Kong in innovation:
(1) Hong Kong firms in Guangdong can conduct innovation;
(2) Hong Kong can serve as the research base in the PRD;
(3) Innovation exchanges can be facilitated between the duo.
Secondly, we can classify innovation activities into different types. According to
the Oslo Manual, there are 4 types of innovation.
Product innovation Includes significant improvements in
technical specifications, components and
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materials, incorporated software, user
friendliness or other functional
characteristics.Process innovation Includes significant changes in
techniques, equipment and/or software.Marketing innovation Any new marketing method including
significant changes in product design or
packaging, product placement, product
promotion or pricing.Organizational innovation Includes a new organisational method in
the firm’s business practices, workplace
organisation or external relations.
Accordingly, we can analyze the present strengths and weaknesses of Hong Kong
as an innovation hub. The Oslo Manual again provides a convenient framework that
defines the favorable institutional environment for innovation. We can see in the
table below that Hong Kong already endows these sets of basic infrastructure.
Required Infrastructure / Settings Hong KongEducational system - Hong Kong has a 9-year
compulsory education system
that provides basic knowledge to
its labour
- Hong Kong has several high-rank
world-class universities that
provides skilled labour and also
serves as research institutesCommunications - Hong Kong has well-developed
transport infrastructure, for
instance, a sophisticated MTR
network
- Hong Kong has been providing
one of the best
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telecommunication and internet
servicesFinancial institutions - Hong Kong is well-known as a
financial centre
- Many banks and financial
institutions set up their
headquarters in Hong KongLegislative and macro-economic settings - Hong Kong has a sound legal
system
- The linked exchanged rate system
has provided stabilityMarket accessibility - Until recently, Hong Kong’s
market environment is still very
dynamic
- Setting up of businesses is very
convenient
It is interesting, however, to investigate the areas where Hong Kong lacks either
capacity or initiatives for innovation. It should be noted that Hong Kong’s R&D
expenditures are constantly lower than those in other NIEs (see figure below). In
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addition, according to a recent report, firms generally do not rely on universities and
public research organizations for product and process innovation. If we consider the
fact that the Hong Kong government’s support for innovation is based primarily on
university-industry links, this reflects inefficiency in input-output relationship. Hong
Kong firms are also characterized by their market-oriented investment for any type of
innovation, which may hinder long-term technological advance. The
shortsightedness is also seen in public R&D allocations, which emphasize short-term
returns.
We suggest several strategies to address these problems. At the government
level, it is imperative that Hong Kong should recognize the importance of innovation
to Hong Kong firms and (once recognized) provide the necessary fund support. In this
regard, Hong Kong has made some progress. For instance, since 2006, 5 Research
and Development Centres and the InnoCentre are established. There is also the
setting up of the Innovation and Technology Fund. However, a bigger problem is how
coordination is done, for which the Innovation and Technology Commission is
responsible. As pointed out in a paper1, more varieties of funding schemes should be
pursued as to increase the forward-looking capabilities of innovation projects, for
instance, schemes that do not require industry sponsorship. Besides, the approval
process must be simplified as innovation is in essence very much related to time.
At the firm level, information exchanges can be facilitated through exhibitions
and joint research, because R&D cooperation means the sharing of risk and financial
burden, which can overcome shortsightedness of individual firms. Universities, as
another set of major players, should enhance their connections with firms as to
understand the demands for innovation. This can not only utilize the functions of
universities as research bases, but also increase the sustainability of research
activities as a market scope for innovation products is provided. Last but not the
least, we should note that Hong Kong firms can also cooperate with universities and
research institutes based in the mainland. Only with a broader vision can
1 Savantas Policy Institute (2009). ‘‘Reinvigorating Hong Kong’s Innovation System: An Overview of Hong Kong Innovation Project’’. pp12
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stakeholders of Hong Kong fully embrace the opportunities of Guangdong industrial
upgrading.
VII. Conclusion
This paper reviews several areas that Hong Kong can develop and benefit from in
Guangdong’s industrial upgrading. Indeed, it should be pointed out that these areas
are not separate. It is not difficult to see that linkages exist among these areas. For
example, innovation and R&D actually provides the technological base for high-end
manufacturing industry development. The development of ODM/OBM businesses is
also beneficial to the producer service sector. While the harsh situation faced by
Hong Kong manufacturers in Guangdong is introduced, the innovation and R&D is
actually a ‘survival strategy’. The interrelations between all these sections can be
summarized as: coordination and cooperation.
To facilitate these efforts, the Hong Kong government certainly has a role to play.
We argue that based on increasing complexities of businesses, regional specialization
and integration, and the necessary public good such as R&D expenditure, Hong Kong
can no longer follow a ‘laissez-faire’ policy. To advance economic achievements, to
embrace the opportunities of 12-5 and to face the challenges in a new era, the Hong
Kong government needs to play a proactive role in coordinating different areas of
development and, negotiating and cooperating with the Guangdong government.
Only by doing so, Hong Kong will not risk becoming irrelevant to the rapid and
dynamic changes happening in Mainland China. We believe the structural
transformation in Guangdong can produce a win-win solution to both parties
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involved.
List of Reference:Hong Kong Trade Development Council (2011). “Environmental Protection Industry in Hong Kong”. Hong Kong Industry Profiles
Yeh, Anthony (2008). “Hong Kong’s Producer Services Linkages with the Pearl River Delta”, Centre of Urban Planning and Environmental Management
Hong Kong Marine Department (2011). “Ranking of Container Ports of the World”
HKSAR Government (2010). “Supplementary Notes for Hong Kong enterprises to implement CDM projects on Mainland”
Hong Kong Productivity Council (2011). “Cleaner Production Partnership Programme Overview”
Savantas Policy Institute (2009). ‘’Reinvigorating Hong Kong’s Innovation System: An Overview of Hong Kong Innovation Project’’
Web Sources:NewsGD - 12th Five Year Planhttp://www.newsgd.com/specials/12thFive-Year/default.htm
Cleaner Production Partnership Programmehttp://www.gov.hk/en/residents/environment/business/cppp.htm
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