Structure and Development of the Economy

With its strategic location at the doorway to the Mainland and on the international time zone that bridges the time gap between Asia and Europe, the Hong Kong Special Administrative Region (HKSAR) has been serving as a global centre for trade, finance, business and communications. Hong Kong is now ranked the 10th largest trading entity in the world. It operates the busiest container port in the world in terms of throughput, as well as one of the busiest airports in terms of number of passengers and volume of international cargo handled. In addition, it is the world's 12th largest banking centre in terms of external banking transactions, and the seventh largest foreign exchange market in terms of turnover. Its stock market is Asia's third largest in terms of market capitalisation.

    Hong Kong is characterised by a high degree of internationalisation, business-friendly environment, rule of law, free trade and free flow of information, open and fair competition, well-established and comprehensive financial network, superb network of transport and communications infrastructure, sophisticated support services, and a well-educated workforce complemented by a pool of efficient entrepreneurs. Added to these is the substantial amount of fiscal reserves and foreign exchange reserves, a fully convertible and stable currency, and a simple tax system with a low tax rate. On these virtues, Hong Kong is widely regarded as amongst the freest and most competitive economies in the world. The US Heritage Foundation ranks Hong Kong as the world's freest economy for the ninth year in a row in 2003. The Fraser Institute in Canada and the Cato Institute in the United States, in conjunction with a network of independent research institutes in 54 other countries, also consistently rank Hong Kong as the world's freest economy. The World Economic Forum, based in Switzerland, ranks Hong Kong as the fourth most competitive economy in Asia and the 17th in the world (Chart 1).

Chart 1 Gross Domestic Product
(year-on-year rate of change in real terms)
 
   
  Over the past two decades, the Hong Kong economy grew by an average of 5.1 per cent in real terms, outpacing the corresponding growth rate of 2.8 per cent for OECD economies as a whole. In 2002, the economy rose by 2.3 per cent in real terms, up from a 0.5 per cent growth in 2001.  

    Over the past two decades, the Hong Kong economy has more than doubled in size, with GDP growing at an average annual rate of 5.1 per cent in real terms. This outpaces considerably the growth of the world economy and the Organisation for Economic Cooperation and Development (OECD) economies. Over the same period, Hong Kong's per capita GDP has doubled, giving an average annual growth rate of 3.8 per cent in real terms. Its level at US$23,800 in 2002 was amongst the highest in Asia, next only to Japan.

    In line with the increased external orientation of the Hong Kong economy, trade in goods expanded by eight times and trade in services by three times in real terms over the past two decades. In 2002, the total value of visible trade (comprising re-exports, domestic exports and imports of goods) reached $3,164 billion, corresponding to 251 per cent of GDP. This was distinctly larger than the ratios of 138 per cent in 1982 and 235 per cent in 1992. If the value of exports and imports of services is also taken into account, the ratio is even greater, at 295 per cent in 2002, compared with 173 per cent in 1982 and 275 per cent in 1992.

    As another indication of the high degree of external orientation, the stock of inward direct investment in Hong Kong amounted to $3,270 billion in market value at end-2001, equivalent to 257 per cent of GDP. Hong Kong is the second most favoured destination for inward direct investment in Asia, next only to the Mainland. The corresponding figures for the stock of outward direct investment in Hong Kong were likewise substantial, at $2,749 billion and 216 per cent, much larger than those for many other economies in Asia. As a major financial centre in the region with huge cross-territory fund flows, Hong Kong's external financial assets and liabilities were also substantial, at $8,351 billion and $6,283 billion respectively at end-2001. The corresponding ratios to GDP in that year were 658 per cent and 495 per cent. Reflecting Hong Kong's sound international investment position, net external financial assets amounted to $2,068 billion at end-2001, equivalent to 163 per cent of GDP. As to gross external debt, which is the sum of the non-equity liability components in international investment, it stood at $2,740 billion at end-2002, equivalent to 217 per cent of GDP. Yet the major proportion of it arose from normal operations of the banking sector, and the Government incurred no external debt at all.

    The Gross National Product (GNP), comprising GDP and net external factor income flows, stood at $1,287 billion in 2002. This was higher than the corresponding GDP by 2.2 per cent, owing to the sustained net inflow of external factor income. In gross terms, inflows and outflows of external factor income remained substantial in 2002, at $324 billion and $297 billion respectively, equivalent to 26 per cent and 24 per cent of GDP. This was related to the huge volume of both inward and outward investment in Hong Kong.

Contributions of the Various Economic Sectors

Primary production (including agriculture, fisheries, mining and quarrying) is now trivial in Hong Kong, in terms of both value-added contribution to GDP and share in total employment. This reflects the predominantly urbanised nature of the economy.

    Secondary production (comprising manufacturing, construction, and supply of electricity, gas and water), which constituted a significant contributor to GDP up to the early 1980s, has diminished in relative importance since then. Within this broad sector, the value-added contribution from manufacturing shrank noticeably, from 23 per cent in 1981 to 15 per cent in 1991 and even more to only 5 per cent in 2001, consequential to an ongoing relocation of the more labour-intensive production processes to the Mainland. Also relevant was the concurrent rapid expansion of the services sector, along with an upsurge in re-export, transhipment and offshore trade, tourism, transport, telecommunications, financial services, and various other professional and business support services. For the construction sector, its contribution to GDP edged lower from 7 per cent in 1981 to 5 per cent in 1991, and stayed at roughly that level afterwards. As for the supply of electricity, gas and water, the corresponding share held relatively stable, at around 2-3 per cent over the past two decades (Chart 2).

Chart 2 Gross Domestic Product by broad economic sector  
   
     
  Along with a profound shift in economic structure, the share of the tertiary services sector in GDP has continued to increase, whereas the share of the secondary sector has dwindled further over the past two decades.  

    The economic reform and open door policy in the Mainland has not only provided an enormous production hinterland and market outlet for Hong Kong's manufacturers, but has also created abundant business opportunities for a wide range of service activities. These activities include specifically freight and passenger transport, travel and tourism, telecommunications, banking, insurance, real estate, and professional services such as financial, legal, accounting and consultancy services. In consequence, the Hong Kong economy has become increasingly service-oriented since the 1980s.

    Reflecting this, the share of the tertiary services sector (comprising the wholesale, retail and import/export trades, restaurants and hotels; transport, storage and communications; financing, insurance, real estate and business services; community, social and personal services; and ownership of premises) in GDP leaped, from 67 per cent in 1981 to 77 per cent in 1991 and further to 87 per cent in 2001.

    The profound change in the economic structure was also borne out by a broadly similar shift in the sectoral composition of employment. Over the past two decades, the share of the services sector in total employment followed a continuous uptrend, rising distinctly from 51 per cent in 1982 to 69 per cent in 1992 and further to 84 per cent in the first three quarters of 2002. Yet the corresponding share for the manufacturing sector kept on shrinking, from 38 per cent in 1982 to 22 per cent in 1992 and further to only 6 per cent in the first three quarters of 2002 (Chart 3).

Chart 3 Employment by broad economic sector  
   
     
  Consequential to the ongoing relocation of the less skill-intensive and lower value-added manufacturing processes to the Mainland, as well as the strong growth in service activities in Hong Kong, the tertiary services sector has expanded markedly and overtaken the secondary sector to become the largest employer in the economy since 1981.

* Average of Q1 to Q3 2002.
 

The Services Sector

The services sector has not only flourished but also diversified in types of activities, concomitant with the structural transformation of the economy. Trade-related and tourism-related services, community, social and personal services, and finance and business services such as banking, insurance, real estate and a host of related professional services, have all grown distinctly over the past two decades. Strong expansion was also observed in information technology in the more recent years, especially those pertaining to telecommunications services and Internet applications, in line with the shift in economic structure more towards a knowledge-based economy.

    On trade in services, exports and imports of services both grew by an annual average of 7 per cent in real terms over the past two decades. In 2001, civil aviation, travel and tourism, trade-related services, and various financial and banking services were the largest components of trade in services. Within exports of services, offshore trading and purchasing/merchandising services were the most important component, accounting for 33 per cent of the total value in 2001. This was followed by transportation (with a share of 29 per cent), travel and tourism (20 per cent), and financial and banking services (7 per cent). As to imports of services, travel and tourism were the largest component, accounting for 50 per cent of the total value in 2001. Transportation was in second place (with a share of 26 per cent), followed by offshore trading and purchasing/merchandising services (6 per cent), and financial and banking services (3 per cent).

    Between 1991 and 2001, net output or value-added of the services sector as a whole rose visibly, by an annual average of 8 per cent in value terms. Amongst the major constituent sectors, net output of community, social and personal services had the fastest growth (at an average annual rate of 11 per cent). This was followed by transport, storage and communications; the wholesale, retail and import/export trades, restaurants and hotels; and financing, insurance, real estate and business services (at an average annual rate of 7 per cent each).

    In 2001, the wholesale, retail and import/export trades, restaurants and hotels continued to render the largest value-added contribution to GDP, with a share of 27 per cent. This was followed by financing, insurance, real estate and business services (at 23 per cent), community, social and personal services (22 per cent), and transport, storage and communications (10 per cent) (Chart 4).

Chart 4 Gross Domestic Product by major service sector
   
   
  Over the past two decades, community, social and personal services had a more distinct increase in net output than most of the other service sectors. Yet ranked in terms of value-added contribution to GDP, the wholesale, retail and import/export trades, restaurants and hotels, together with financing, insurance, real estate and business services, were the two largest service sectors in 2001.

    In terms of employment, the wholesale, retail and import/export trades, restaurants and hotels sector was again the largest, accounting for 32 per cent of the total employment in the first three quarters of 2002. This was followed by community, social and personal services (with a share of 26 per cent), financing, insurance, real estate and business services (15 per cent), and transport, storage and communications (11 per cent) (Chart 5).

Chart 5 Employment by major service sector
   
   
  Over the past two decades, financing, insurance, real estate and business services showed the fastest employment growth. But in terms of employment size, the wholesale, retail and import/export trades, restaurants and hotels, as well as community, social and personal services were the two largest employers in the economy in 2002.

* Average of Q1 to Q3 2002.

The Manufacturing Sector

Manufacturing firms in Hong Kong are renowned for their versatility and flexibility. The existence of many small establishments, connected under an extensive local sub-contracting network, has greatly facilitated producers in coping with changing demand conditions in the overseas markets. Moreover, through increased outward processing arrangements in the Mainland, Hong Kong's productive capacity has effectively been expanded by multiples, which has helped maintain the price competitiveness of its products. A predominant proportion of Hong Kong's manufacturing output is destined for export.

    Besides relocating the more labour-intensive production processes to the Mainland, Hong Kong's manufacturers have also been striving hard to diversify their products and markets, in face of increased challenges from globalisation of trade and keener competition from other export producers. Concurrently, productive efficiency and product quality have been continuously upgraded by incorporating more advanced skills and technology.

    Within the local manufacturing sector, textiles and clothing remain the most important industries, notwithstanding continued decline in their relative significance over the years. Other major industries include machinery and equipment, electronics, printing and publishing, food processing and metal products. Generally speaking, those manufacturing operations still remaining in Hong Kong are more knowledge-based with a higher value-added and a greater technology content. Between 1992 and 2002, labour productivity in the local manufacturing sector, as measured by the ratio of the industrial production index to the manufacturing employment index, rose distinctly, by an annual average of about 8 per cent (Chart 6).

Chart 6 Output per person engaged in
the local manufacturing sector
(March 1991=100)
 
     
     
  Labour productivity in the local manufacturing sector has gone up substantially over the past decade.

* Average of Q1 to Q3 2002.
 

    In 2002, the United States and the Mainland were the two largest markets for Hong Kong's domestic exports, both accounting for 32 per cent of the total. Other major markets included the United Kingdom (6 per cent), Taiwan (3 per cent), Germany (3 per cent), the Netherlands (3 per cent) and Japan (2 per cent). In the more recent years, more markets were developed for Hong Kong's exports, including markets in the Middle East, Eastern Europe, Latin America and Africa.

Increasing Economic Links between the HKSAR and the Mainland

Since the Mainland adopted an economic reform and open door policy in 1978, economic links between Hong Kong and the Mainland have gone from strength to strength. This has brought about substantial economic benefits to both places.

    Visible trade between Hong Kong and the Mainland has expanded rapidly since 1978, at an average annual rate of 22 per cent in value terms. However, the growth rate in two-way trade moderated in the more recent years, from an average annual rate of 12 per cent in value terms during 19921997 to that of 4 per cent during 19972002, owing to increased direct shipment of goods into and out of the Mainland upon the enhanced port facilities and simplified customs procedures there. This notwithstanding, the Mainland was still Hong Kong's largest trading partner in 2002, accounting for 42 per cent of the total trade value in Hong Kong. The bulk (specifically, 90 per cent) of Hong Kong's re-export trade was related to the Mainland, making it the largest market for as well as the largest source of Hong Kong's re-exports. Reciprocally, Hong Kong was the Mainland's third largest trading partner in 2002 (after Japan and the United States), accounting for 11 per cent of the Mainland's total trade value (Chart 7).

Chart 7 Visible trade between Hong Kong and the Mainland  
     
     
  Since the Mainland adopted an economic reform and open door policy in 1978, there has been a rapid expansion in merchandise trade, especially re-export trade, between Hong Kong and the Mainland.  

    In the more recent years, there has been an increasing shift in the mode of Hong Kong-Mainland trade from re-exports to offshore trade. Between 1990 and 1995, Hong Kong's exports of trade-related services grew by an average of 5 per cent per annum in real terms, much slower than the growth in re-exports involving the Mainland, at an average of 22 per cent per annum in real terms. The growth pattern was reversed during 1995 to 2002, when exports of trade-related services surged by an average of 14 per cent per annum in real terms, outpacing the growth in re-exports involving the Mainland, at an average of 6 per cent per annum in real terms (Chart 8).

    Over the past two decades, there has also been a sharp increase in service and investment flows between Hong Kong and the Mainland. At present, Hong Kong is a major service centre for the Mainland generally and South China in particular, providing a wide array of financial and other business support services such as banking and finance, insurance, transport, accounting and sales promotion. It is also a principal gateway to the Mainland for business and tourism. In 2002, 56 million trips were made by Hong Kong residents to the Mainland, representing an increase of 7 per cent over 2001. The number of trips made by foreign visitors to the Mainland through Hong Kong also went up, by 9 per cent to three million.

Chart 8 Changing mode of Hong KongMainland trade
(year-on-year rate of change in real terms)
 
     
     
  There has been an increasing shift in the mode of Hong KongMainland trade from re-exports to offshore trade in the more recent years.  

    Hong Kong has been the largest source of external direct investment in the Mainland. The cumulative value of Hong Kong's realised direct investment in the Mainland amounted to US$205 billion at end-2002, accounting for about half of the total inward direct investment there. Over the years, there has been a noticeable shift in the composition of Hong Kong's direct investment across the boundary, from industrial processing to a wider spectrum of business ventures, such as hotels and tourist-related facilities, real estate and infrastructure development. Relative to other places in the Mainland, Hong Kong's economic links with Guangdong are the most intimate. At end-2001, the cumulative value of Hong Kong's realised direct investment in Guangdong was US$79 billion, accounting for nearly three-quarters of its total inward direct investment. Currently, over five million Chinese workers, probably many more, are said to have been employed in the province by industrial ventures with Hong Kong interests. This is about 26 times the size of Hong Kong's own manufacturing workforce.

    In the opposite direction, there has been likewise a sizeable flow of investment capital from the Mainland to Hong Kong over the past years. By end-2001, the Mainland had invested a total of US$123 billion in Hong Kong, making it the largest source of external direct investment. About 2 000 Mainland enterprises currently operate in Hong Kong. While these enterprises maintain high investment stakes in such traditional lines of business as the import/export trade, wholesale/retail trade, banking, transport and warehousing, their investment has increasingly diversified into other spheres such as real estate, hotels, financial services and infrastructure development.

    In tandem with the upsurge in cross-boundary flows of trade, investment and people, financial links between Hong Kong and the Mainland have also been growing at a generally strong pace over the past two decades. Yet there was a distinct slackening in the more recent times, reflecting reduced lending from Hong Kong's financial institutions to Mainland banks amidst abundant liquidity in the Mainland, as well as fewer fund-raising activities by Mainland enterprises in Hong Kong and thus lesser Hong Kong dollar placements from those enterprises in Hong Kong's banking system. Comparing end-2002 with a year earlier, external liabilities of Hong Kong's authorised institutions (AIs) to entities in the Mainland fell by 14 per cent to $289 billion, while external claims of Hong Kong's AIs on entities in the Mainland contracted by 36 per cent to $127 billion.

    The Bank of China (Hong Kong) Limited is the second largest banking group in Hong Kong after the HSBC Group. It was established on October 1, 2001 through restructuring 10 member banks of the former Bank of China Group. It has taken on the issuance of Hong Kong dollar banknotes, as was hitherto performed by the former Bank of China since May 1994. (The other two note-issuing banks are the Hongkong and Shanghai Banking Corporation, and the Standard Chartered Bank.) The other three state-owned commercial banks, namely the China Construction Bank, the Agricultural Bank of China and the Industrial and Commercial Bank of China, were all granted banking licences to operate in Hong Kong in 1995. Meanwhile, the HSBC Group, the Bank of East Asia and the Standard Chartered Bank continue to be amongst the best-represented foreign banks in the Mainland.

    Hong Kong has been serving as a major funding centre for the Mainland. Apart from being a direct source of funds, it also provides a window through which foreign funds can be channelled efficiently into the Mainland for financing development projects there. So far, most of the Mainland's fund-raising activities in Hong Kong have taken the form of syndicated loans. Yet in the more recent years, an increasing number of Mainland-related banks and enterprises have raised funds through issuance of negotiable certificates of deposit, bonds and shares. Since mid-1993, H shares have been listed on Hong Kong's stock exchange by an increasing number of large state-owned enterprises (SOEs) in the Mainland. At end-2002, a total of 54 SOEs were so listed in the Main Board of the Hong Kong Stock Exchange, raising a total equity capital of $144.5 billion. Of these 54 enterprises, four were listed in 2002, raising $16.9 billion. In addition, 71 other Mainland-related enterprises have been listed on the Main Board since 1986, raising a total equity capital of $584.1 billion. Of these 71 enterprises, three were listed in 2002, raising $51.2 billion. Another 20 SOEs and one other Mainland-related enterprise were listed in the Growth Enterprise Market (GEM) set up in November 1999, raising a total equity capital of $2.6 billion and $0.4 billion respectively.

    Apart from SOEs, private enterprises in the Mainland also find the stock market in Hong Kong, particularly the GEM, a useful channel to raise equity capital. In turn, this can help broaden the base of Hong Kong's stock market, and help entrench further Hong Kong's position as a fund-raising centre for enterprises in the Mainland.

    With continuing reform and further liberalisation of the Mainland economy, particularly after China's entry into the World Trade Organisation, more foreign investment can be expected to flow into the Mainland. Hong Kong's service hub role for the Mainland will continue to strengthen. Hong Kong possesses a strong niche in partnering with as well as in providing various necessary services to foreign enterprises seeking to enter the Mainland market. In the other direction, as more Mainland enterprises seek to extend outward in due course, Hong Kong can also help these enterprises to gain access to the overseas markets.