“The relationship with China” is a misleading description in many ways: Hong Kong is now part of China. It is a “Special Administrative Region” under China's “one country, two economic systems” policy. However Hong Kong's autonomy is used for their own convenience by China, Hong Kong, and the transnational corporations active in them. While this paper does not focus on trade, the trading relationship shows clearly the relationship and increasing integration between the two economies. It is also tied closely to investment, because as will be seen, this trade is closely related to the activities of the transnational corporations active in the region.
The Hong Kong Government's web site quoted above says:
Hong Kong is the premier gateway for trade and investment moving into and out of the Chinese mainland. Hong Kong is also increasingly a source of expertise and funding for China's efforts to modernize its economy.
Hong Kong continues to handle about half of all exports to Mainland China, and accounts for about half of foreign direct investment there.
Every day there are about 800 sailings, 100 flights, 35 train connections and 27,000 vehicle crossings between Hong Kong and Mainland China.
About 50,000 Hong Kong companies have production facilities in southern China, employing some five million workers in total. Approximately 100,000 Hong Kong expatriates work on the mainland, mainly in managerial and training positions.
The Chinese mainland is also a major investor in Hong Kong's economy. There are approximately 2,000 mainland enterprises registered in Hong Kong with a gross asset value approaching US$200 billion. The mainland is Hong Kong's third-largest source of foreign direct investment.
It considers that China's accession to the WTO “will only enhance [Hong Kong's] status as a key world trading power”. It lists opening of the financial sectors, and the telecommunications industry as key areas.
The web site continues:
Another of Hong Kong's greatest strengths lies in its close ties to a variety of firms in Mainland China and Southeast Asia. Hong Kong traders and manufacturers have the ability to source materials from numerous factories around Asia and India, even as far away as the Middle East and West Africa, quickly and cheaply. Hong Kong garment firms can put together a new shirt according to a retailer's specifications and produce in quantity in a few weeks time. The network of suppliers and factories that Hong Kong firms can call upon, in literally a moment's notice, ensures that partner firms from overseas can get good bargains, top quality merchandise and quick delivery of goods on very short notice.
This “intermediation” function should not be underestimated. Hong Kong is moving rapidly away from manufacturing based on low-cost labour, making money instead from organizing production on behalf of buyers – mainly in the industrialized world – using the cheapest raw materials, factories and labour, wherever it can find them. Since China is currently one of the cheapest sources of labour, it is ideally placed for this function. Some data illustrate the extent of this.
Hong Kong's per capita GDP in 1999 was US$23,200 (or NZ$45,600) – 70% higher than New Zealand's NZ$26,700 (December 1999). Hong Kong's per capita GDP had fallen from US$26,100 in 1997 as a result of the financial crisis. While Hong Kong has among the most unequal distributions of income in the world6 (and this inequality is deepening), increasing poverty, no minimum wage and a large migrant population that is easily exploited, it is no longer a low-wage economy. The average daily wage for production workers in Hong Kong manufacturing is approximately NZ$104 (HK$339). (Sources: Quarterly Report of GDP Estimates, First Quarter 2000, and Average Wage Rates for Employees up to Supervisory Level, 29 December 2000, Hong Kong Census and Statistics Department; and GDP March 2000, Statistics New Zealand.)
Because of that, Hong Kong is moving out of labour-intensive manufacturing. Manufacturing has fallen steadily from 23.7% of GDP in 1980 to 5.7% in 1999 (HKCSD, “Gross Domestic Product by economic activity”, 24 November 2000). Instead, according to academics Robert Feenstra and Gordon Hanson7 ,
Since 1980, Hong Kong has begun to specialize more heavily in business services, particularly those related to trade and investment in China. China's export manufacturers are concentrated in southern coastal provinces, especially Guandong which borders Hong Kong. Over the last two decades, many Hong Kong manufacturing firms have moved their production facilities to Guandong, which they manage from headquarters in Hong Kong. Hong Kong firms typically supply plants in China with raw materials and often ship the goods through Hong Kong for inspection, finishing, or packaging before exporting them to a final destination.
Working conditions in China's export zones can be appalling for the migrant workers attracted there. Wages are US$50-100 (approximately NZ$110-220) per month including overtime and bonuses. Reports document workers frequently working 10-16 hour days and 60 hours over a six day week, dangerous working conditions, poor food, military camp-like dormitories for accommodation, oppressive conditions at work such as rules against talking or going to the toilet without permission, insecurity of work, suppression of the right to organize, and child labour, all on top of the problems of discrimination, loss of rights, and separation from families as migrants.
As a result, Hong Kong's export trade is increasingly “re-exports” – that is, exporting imported goods that have undergone no further processing or only simple processing in Hong Kong. According to Feenstra and Hanson, that simple processing could include “sorting or packaging, or service activities, such as marketing or transport”. According to HKCSD's definitions, re-exports have not undergone “a manufacturing process which has changed permanently the shape, nature, form or utility of the product” in Hong Kong. These definitional issues are central to determining “rules of origin” in trade agreements such as the one proposed. However, as will be seen shortly, a hallmark of Hong Kong commerce is the control that Hong Kong traders have over the processing of exports in a large number of countries. In their own interests, and those of their clients, they can be expected to manipulate processing to minimally satisfy any trade agreement's “rules of origin” to gain entry to that market.
Between 1993 and 2000, the proportion of Hong Kong's exports that were “re-exports” rose from 78.7% to 88.5%. A third (33.9% in 1999) of those re-exports are to the mainland of China, and 43.6% of Hong Kong's imports are from the Mainland. Feenstra and Hanson report that “over the period 1988-1998, 53% of Chinese exports were shipped through Hong Kong in this manner”.
(Note that in the year to November 2000, 39% of Hong Kong's total trade was with China, according to HKCSD.)
HKCSD reports that
In January-September of 2000, 52% of Hong Kong's total exports to the Mainland were for outward processing; the figure was 73% for domestic exports and 49% for re-exports. On the other hand, 79% of Hong Kong's imports from the Mainland were related to outward processing. Over the same period, 85% of Hong Kong's re-exports of Mainland origin to other places were produced through outward processing in the Mainland.8
Hong Kong intermediaries benefit hugely from this trade, according to Feenstra and Hanson:
Net of customs, insurance, and freight charges, Chinese goods are much more expensive when they leave Hong Kong than when they enter. For the 1988-1998 period, the average markup on Hong Kong re-exports of Chinese goods was 24%. The income flow from these entrepôt activities is large. In 1996, re-exports of Chinese goods equalled 52% of Hong Kong GDP. In that same year, Hong Kong markups on these re-exports totalled 10% of GDP, while manufacturing accounted for only 7% of GDP.
Some of the re-exporting is after processing of imports which may have been partially processed in Hong Kong:
Traders are often more than middlemen. Many firms that import goods from China for re-export engage in outward processing. Before importing goods from China, they may purchase raw materials on the world market, process these materials in Hong Kong or elsewhere, and export the unfinished goods to China for yet further processing. Hong Kong's re-exports may then be the final leg in a much longer journey. In 1998, outward-processing trade accounted for 48% of Hong Kong exports to China and 83% of Hong Kong imports from China.
Markups vary greatly. “Markups appear to be highest in the rich regions of North America, Oceania, and Western Europe and lowest in the poor regions of Africa and Latin America.” Feenstra and Hanson found that median markups range from 28% to 34%. They appeared to be highest for light manufactured articles and for machinery and transport equipment (where 70% of China's exports are re-exports), and lowest for mineral fuels, and for animal and vegetable oils.
The use of Hong Kong by China appears to be because Hong Kong middlemen have greater knowledge of, and already are established in, certain markets for Chinese goods. Hong Kong tends to take Chinese non-commodity goods which are “differentiated” – that is, sold on the basis of “quality” or branding. It also tends to take goods which have higher price variability.
But the use of Hong Kong is also to allow transnational corporations who manufacture in China to transfer prices, according to evidence presented by Feenstra and Hanson - that is, to make their profits in low-tax countries, rather than where they sell the final goods. The markups raise prices in low-corporate-tax Hong Kong so that profits are made there rather than in China or in North America, Oceania, and Western Europe where the goods are mainly sold. The intensive use of tax shelters by investors in Hong Kong and Hong Kong investors (see above) is consistent with this explanation.
Using Hong Kong middlemen may also enable transnationals to avoid or take advantage of import quotas in the rich countries, especially those under the Multi-Fibre Agreement (MFA) for footwear, clothing and textiles. Markups are 20-22% higher on MFA goods. Contrary evidence is that China re-exports relatively less MFA goods.
Transnational corporations (“foreign-invested enterprises” or FIEs in China's terminology) accounted for 41.9% of China's exports in 1998 – up from 4.7% in 1988. The FIE share in China's exports to Hong Kong is consistently larger than the FIE share in direct Chinese exports, “which may be attributable to the central role that Hong Kong plays in coordinating activities in China by FIEs” according to Feenstra and Hanson.
Hong Kong traders have considerable control of the processing and can be expected to attempt to manipulate that to minimally satisfy whatever “rules of origin” requirements are stipulated in a trade agreement:
Outward processing is not the sole, or even most well established, motivation for Hong Kong re-exports of Chinese goods. Many re-exporters own no manufacturing facilities; rather, they serve as middlemen in transactions between buyers and sellers located in distinct foreign markets. One well-known Hong Kong trading house is Li & Fung, which specializes in trading, distribution, and retailing. In 1998 it had global sales of $2 billion and offices in over 20 countries. The typical arrangement is for a foreign manufacturer or retailer to approach Li & Fung with a product they would like to purchase or have produced. In simple transactions, Li & Fung is purely a matchmaker: “The idea is that maybe foreigners don't know which factory to go to, so you perform an introductory role, maybe a quality-control role and there it stops”, says its managing director. In more complex transactions, Li & Fung oversee the entire fabrication of a good, from purchasing raw materials and planning production to monitoring manufacturing among the 7,500 independent plants to which it subcontracts orders. In return for its trading services, Li & Fung is reported to earn commissions of 7%-12% on each order it fills.
Given all the above, it is surprising and notable that 58% of Hong Kong's “domestic exports” were still “articles of apparel and clothing accessories” and textiles in the year ended November 2000 – worth about NZ$25 billion. (HKCSD, “Domestic Exports by Principal Commodity” and “Domestic exports to ten main destinations”, 9 January 2001). While “domestic exports” are defined for HKCSD's purposes as “the natural produce of Hong Kong or the products of a manufacturing process in Hong Kong which has changed permanently the shape, nature, form or utility of the basic materials used in manufacture”, the move of Hong Kong out of manufacturing and its high and increasing integration with external subcontractors – especially in China – implies that the “manufacturing” of these items in Hong Kong is likely often to be minimal. A large part of the value is likely to be markup, with just enough processing to satisfy “Hong Kong origin” requirements of the importing country.
It will be exceptionally difficult to define rules of origin, for either goods or services, that are enforceable and distinguish Hong Kong-made “domestic” products from ones substantially made in China or in the thousands of other low-cost plants around the world used by Hong Kong intermediaries. And unlike Singapore, where it could be said that trade in the most sensitive area – textiles, clothing and footwear (TCF) – was negligible at the time of signing (ignoring the likelihood that the agreement would encourage traders to use Singapore to avoid tariffs), there is huge potential for Hong Kong's exports to devastate the remaining New Zealand TCF sector.