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Home , Economy of Hong Kong, Greater China

A Comparative Study of Economic Integration within Greater : Perspectives of Kong and

Chi-jen Wu PhD Student in Economics SOAS

Abstract Since China embarked on its open-door reforms from the late 1970s, Greater China has emerged out of a non-institutional economic integration amongst the three Chinese economies - , and Taiwan. Due to geographical, cultural proximities and higher levels of economic development, the latter two economies have contributed enormous foreign direct investment (FDI) to the former. On the one hand, this has resulted in a massive exodus of the manufacturing sector especially from Hong Kong, and with lesser magnitude, Taiwan. The integration has, on the other, driven Hong Kong towards specialization of the services (especially the financial and tourist activities) and Taiwan the high-technology , whilst the labour-intensive exportables took off in mainland China. At the first glance, comparative advantage has been at play. From the viewpoint of mainstream economics, economic integration across borders will promote the allocative efficiency of resources and thus the overall well-being of participating economies. The orthodox analysis remains, however, static in nature and the gains through exchange of comparative advantages are short-term and once for all. Moreover, it fails to explain why and how such comparative advantage takes shape over time. From a dynamic perspective of the home economy and through the comparative study on Hong Kong and Taiwan, this paper argues that the integration outcome lies in the interplay of initial conditions, which are industrial structure, financial-industrial relationship, culture and more fundamentally, the underlying political economy.

Introduction

The stellar economic performance of Hong Kong and Taiwan in the postwar era needs no rehearsal here. Together with and , they constitute the East Asian miracle, dubbed as the ‘Four Little Tigers/Dragons’, and have aroused interpretations of different schools in development economics for their economic achievements. While there is hardly a consensus on the weight of variant factors’ impact on the course of economic development in these four economies, most analysts agree that the strategy of export-orientation of manufactured goods commonly adopted by these four has greatly helped them in two major ways: one was to reap economies of scale, which otherwise was prohibited due to their small size; another was to increase their foreign earnings, thereby being able to import the needed capital goods and thus to resolve the capital formation problem. Foreign direct investment (FDI) is another factor of significance since it not only boosted exports and increased employment, but more importantly was a major means of technology transfer from advanced countries to these economies.

It is this outward-looking pattern that China imitated, it is said, when it initiated the open-door reforms in the late 1970s. The first four economic special zones set up in 1980 are located nearby Hong Kong and Taiwan with a view to attracting investment from their enterprises. Concomitant with the open-door move of China was the bottleneck of industrial development facing Hong Kong and Taiwan. Against the context of there hardly being technological deepening in Hong Kong, by the mid 1970s the success in the past had caused tremendous rising pressures on domestic wages and rents, which in turn eroded the competitiveness of its enterprises in the world market. ‘As fish finding water,’ the low-cost production environment provided in mainland China became the best exit for the manufacturing sector in Hong Kong. Thereafter on the one hand there occurred a large-scale exodus of numerous small- and medium-sized enterprises (SMEs) from Hong Kong into its hinterland, thereby directly leading to the massive shrinkage of the manufacturing sector in Hong Kong. By the mid 1980s, on the other, Hong Kong quickly resumed its role as entrepôt between China and the rest of the world that it had played before the embargo in 1952. Moreover, China’s rising demand in international financial activities also largely enhanced Hong Kong’s status as an international financial centre.

Taiwanese firms attended this movement only after 1987 – the year when martial law was lifted, foreign exchange control liberalized, NT$ largely appreciated and kinship visit to the Mainland permitted by the Taiwanese authorities. Around the same time Taiwan was facing soaring wages and rents and hostility of environmentalists in its industrial restructuring, the ‘sunset’ industries, mainly composed of SMEs in labour-intensive and technology-unsophisticated production, found relocation to the Mainland an effective means to secure their competitiveness as their counterparts in Hong Kong. Thereafter emerged Greater China – a cross-border economic integration amongst the three Chinese economies. The integration, though a non-institutional one1,

1 Normally, economic integration of different nations takes place only after political consensus is reached, thereby establishing an economic bloc wherein economic discrimination amongst the intensified as China’s reforms gathered pace especially after the ‘South Tour’ of in 1992. A more significant change is, from the mid 1990s, that larger and higher technology-intensive firms in Taiwan started to join the force of setting up subsidiaries in China. As they favoured the Yangtze River Delta, Greater China expanded accordingly out of the two southern provinces, Guangdong and Fujian, into the central coastal area of China.

While the enormous FDI inflows have created millions of jobs and also strongly spurred the export performance of PRC, from the perspective of the home economy, the massive outflows of FDI have had serious but various repercussions on Hong Kong and Taiwan - subject to the domestic economic conditions. Although the economic integration within Greater China is an on-going, dynamic process and both the two smaller economies face some common problems – such as declining economic growth, rising unemployment and worsening income distribution - up to the present day it appears that Hong Kong and Taiwan have evolved along two divergent paths: while the latter is struggling to secure its lead in high-technology industries, the former has transformed itself into a financial and services-based economy.

The different outcomes of economic integration with the Mainland between Hong Kong and Taiwan define the theme of this study. First, we examine the impact of the China factor on the economic restructuring of the two small constituents, followed by an examination on initial conditions of Hong Kong and Taiwan. Deeper determinants are sought after by examining factors of historical legacy, foreign influence, political economy and social culture. Finally we conclude with lessons drawn from this comparison, hoping to throw light on the theory as well as the practice of economic integration within Greater China.

Degrees of ‘Mainlandization’ of Hong Kong and Taiwan

The huge differentials in the manufacturing labour cost on the eve of the emergence of Greater China in 1987, as shown in Table 1, suggest how tempting the relocation to China was to the entrepreneurs in the labour-intensive industries in Hong Kong and Taiwan. It deserves clarification that due both to the FDI outflows control of the Taiwanese authorities and the political uncertainty across the Taiwan Strait, there have been significant ‘circumventing’ FDI taken by the Taiwanese firms, mainly via the

members is less than that vis-à-vis non-member economies. Such economic integration is formally institutionalized, such as NAFTA and EU. British Virgin Islands and Cayman Islands. One survey2 verifies that at least 90 per cent of FDI flows of the Virgin Islands origin were virtually from the Taiwanese enterprises in disguise. Thus in order to address the underestimation problem in the corresponding official statistics of both sides, a simple method is adopted by the study: Virtual Taiwanese FDI inflows in the Mainland are represented by the sum of three registered FDI sources (Taiwan, the British Virgin Islands and Cayman Islands) in the PRC official data.

With this adjustment, Table 2 shows the magnitude of FDI flows within Greater China. From the early 1990s China’ absorption of FDI has been phenomenal, only second to the US and even displaced the latter in the most recent years. However, statistics reveal that the bulk of its FDI inflows was generated from Hong Kong and Taiwan. These two sources, taken together, accounted for nearly 60 per cent of its total FDI absorption in the period 1985-2002. Noteworthily, it is estimated that around one-third of Hong Kong’s FDI outflows were ‘round trippings’ from the Mainland itself, and another one-third were from other countries3. Hence throughout the period Hong Kong’s virtual FDI contribution to China was almost equivalent to that of Taiwan. Moreover, the dynamism of the latter in the most recent years was reinforced by FDI of large corporates in the capital- and technology-intensive industries.

In relative terms and from the perspective of the home economy, for Hong Kong in 2000 the ‘nominal ‘ scale of FDI outflows to the Mainland equaled 10 per cent of its GDP and 36 per cent of its gross fixed capital formation. Corresponding figures for Taiwan were 2 per cent and 10 per cent in the same year. By the same measurements, the US and , the third and fourth largest investors in the Mainland, followed by a far distance (see Table 3).

Divergent Outcomes of Integration with China

One of the most significant impacts of Greater China on Hong Kong and Taiwan was the massive shrinkage of their manufacturing sector. In terms of contribution to GDP, the share taken by the manufacturing sector in Hong Kong dwindled from 22.2 per cent in 1980 to 4.4 per cent in 2002 – an 18 percentage decline in the manufacturing

2 See Zhen-yuan Tong (2001) ‘Global Division of Labour and Interdependence in the Case of Cross-Strait Economics,’ Quarterly Journal of Economic Situation and Review, Vol. 7, No. 3, Dec. 2001 (in Chinese.) 3 See A. Peter Petri (1995) ‘The Interdependence of Trade and Investment in the Pacific,’ in Edward K. Y. Chen and Peter Drysdale (eds.) Corporate Links and Foreign Direct Investment in and the Pacific, Pymble: Harper Educational Publishers, pp. 29-55. share of overall industrial output. Table 4 compares this record of Hong Kong with other small matured economies and finds no parallel. No country in comparison experienced a decline exceeding 5 percentage - except Taiwan, which seconded Hong Kong by a 10 percentage decline. This experience of these two Chinese economies stand in higher contrast to their East Asian peers – Singapore and South Korea.

A number of implications can be drawn from this comparison. First, given the massive FDI flows within Greater China, the correlation between China’s industrial takeoff and the manufacturing loss in Hong Kong and Taiwan suggests that the former was at the expense of the latter two. Secondly, the mere 4.4 percentage in the overall industrial output indicates that by now Hong Kong has transformed into an economy highly specializing in financial and service sectors. Thirdly, although with a 10 percentage decline in the past two decades, in 2002 Taiwan’s manufacturing sector still accounted for 26 per cent of overall industrial output – a level parallel to that in Singapore and South Korea. Fourthly and last, the massive shrinkage of the manufacturing sector suggests that both Hong Kong and Taiwan have undergone a dramatic process of economic restructuring:

Although some scholars have emphasized the feedback benefits of Taiwanese FDI – especially in the PRC – there is some evidence that hollowing out is occurring [in Taiwan]…This problem has its parallel in Hong Kong where the combination of successful growth of the financial and services sector and industrial relocation is leaving a transitional problem of declining economic growth, rising unemployment and worsening distribution of income. (Howe 1996: 11894, italic added)

Although all the four ‘Tigers’ all experienced slower economic growth in the past decade, Table 5 indicates, from a long-run perspective and in real terms, that both Hong Kong and Taiwan have started to lose their growth momentum and lagged far behind Singapore and South Korea in 1990-2003 – a period when the economic integration within Greater China was intensifying. Considering that during the East Asian Financial Crisis in 1997-98 the latter two economies suffered more negative impacts than Hong Kong and Taiwan, the differing economic growth performances in the longer run imply that the China factor may have a stronger and lasting impact, than the Financial Crisis 1997-98, on these four. This picture becomes clearer when

4 Christopher Howe (1996) ‘The Taiwan Economy: The Transition to Maturity of the Political Economy of its Changing International Status,’ in The China Quarterly, No. 148 (December), pp. 1171-95. the employment dimension is taken into account. Table 6 shows that in the most recent years both Hong Kong and Taiwan suffered from an unprecedentedly rising unemployment problem. By contrast, this problem in South Korea and Singapore was less of a concern after the Financial Crisis.

The process of Hong Kong’s dramatic de-industrialization is fully reflected in its foreign trade structure. As Table 7 tells, around the mid 1980s re-exports started to surpass domestic exports, indicating the resuming of Hong Kong’s role as an entrepôt between southern China and the rest of the world. This function was enhanced over time and Hong Kong’s trade expansion was largely re-exports-driven; by 2003 re-exports accounted for 93 per cent of its total exports. By contrast, its domestic exports appeared stagnant in the early 1990s and thereafter started to decline. Hence, its share in total exports dwindled dramatically from 70 per cent in 1980 to 7 per cent only in 2003 – reflecting the disappearing manufacturing sector in Hong Kong.

Admittedly, in the earlier date Greater China’s strong demands for the role of entrepôt of Hong Kong significantly stimulated the latter’s trade-related activities and thus its economic growth. However, as Table 8 reveals, from the mid 1990s the growth momentum of re-exports in Hong Kong also appeared sluggish. This, in part, explains Hong Kong’s worsening economic performance in recent years.

The impact of Greater China on Taiwan’s trade structure was different from Hong Kong. Before the mid 1980s, US and Japan were Taiwan’s foremost export markets, in combination accounting for as high as 60 per cent of its total exports. After the emergence of Greater China, a significant share has been gradually diverted to the Mainland. This trend gained its momentum; by 2002 the latter became the biggest export market for Taiwan (see Figure 1). Concealed in the trade-off relationship amongst Taiwan’s major trading partners is the triangular trade as the relocated Taiwanese firms in the Mainland continued to procure intermediate goods from Taiwan-based firms in order to produce the same labour-intensive manufactured goods for the US market. This reflects a strong industrial linkage between Taiwanese firms in the Mainland and the Taiwan-based firms.

Although with the exceptional export performance vis-à-vis the Mainland, seen from a longer run perspective as illuminated in Table 9, the overall export momentum of Taiwan decreased over time, which in turn strengthened its dependence on the Mainland. As the high-technology industries in Taiwan still by and large relied heavily on key components especially from Japan, the trade surpluses vis-à-vis the Mainland thus became essential for a sustainable development of high technology in Taiwan.

Against the backcloth of Greater China, notwithstanding a ‘hollowing-out’ of the ‘sunset’ industries in the 1990s, evidence shows in the islands this negative impact was offset by an upgrading to the high-technology industries – especially the electronics and PC-related industries which are the most explosive markets in the 1980s and 1990s. This experience markedly distinguishes Taiwan from Hong Kong and is displayed in Figure 2. By 1999 Taiwan had secured an over 5 per cent of the world market share, Hong Kong was driven almost completely out of the hi-tech game. Given the same economic complementarity that both Hong Kong and Taiwanese firms stood to benefit from a greater economic integration with the Mainland at the birth of Greater China, how to explain their divergent paths especially in view of industrial development?

Initial Conditions: Different Industrial Structure between Hong Kong and Taiwan

Initial conditions of industrial and market structures of the home economy shed some light, against the context of Greater China, upon the divergent paths evolved between Hong Kong and Taiwan. Most FDI that have been undertaken by the firms from the two small Chinese economies, in particular in the earlier date, are export-orientated, engaging in labour-intensive and technology-unsophisticated production. Through relocation to the Mainland, they are able to exploit local advantages, thereby effectively saving cost and maintaining their international competitiveness. As the impact of such FDI on the home economy, it hinges, theoretically speaking, on three sorts of linkage between the relocated firms/industries and home-based firms/industries. First is the intra-firm linkage, i.e. the cross-border labour division of production between the parent company and foreign subsidiaries. For large firms, relocating some production lines to the host country would immediately cause a restructuring within the parent company either towards higher-end production or merely headquarter functions in financing, logistics control and administration, etc. For small firms, relocation often means closing down and thus hollowing out their home base. Second is the intra-industry linkage, i.e. forward and/or backward linkages between the home industries and foreign production which has upstream-downstream relationship. This sort of FDI has a higher likelihood to lead home-based firms/industries towards capital- and technology-intensive restructuring. Third and last is the inter-industry/sector restructuring, i.e. the trade-off between the comparatively advantageous and disadvantageous sectors. For some analysts, the inter-industry restructuring seems to be the most treacherous and unreliable because the productivity of the reallocated resources tend not to be increased and thus the overall economy becomes stagnant – even if full employment can be achieved5. To estimate the impact of outward FDI on the home economy, in my view, these three forces should be taken into consideration.

Consider first the Hong Kong-China linkage. The rapid shrinkage of its manufacturing sector and the expanding service industries in combination suggests that the inter-industry/sector restructuring was at work in Hong Kong. Through relocation of the manufacturing units, there formed a pattern of ‘front shops (in Hong Kong) and back factories (in Guangdong).’ Given that the size constraints incurred from the SMEs-dominated market structure, in Hong Kong the inter-industry/sector linkage had a stronger likelihood to take place than the other two linkages. History also tells that in the pattern of Hong Kong’s industrialization, final sales to and procurement of raw materials from foreign markets were by and large divided to trading firms6, rather than being internalized into the manufacturing enterprises as their counterparts (in the form of modern corporates) in the advanced countries. The cooperation between SMEs and trading firms constituted unique sub-contracting production networks7, which was famed for their rapid responsiveness as well as high flexibility – in the past these features carved a great niche in the fashion markets.

A major weakness in this pattern of production in Hong Kong is, however, that after decades of development, its industrial structure remained stagnant, being locked into the labour-intensive and technology-unsophisticated industries with little sign of upgrading8. Two evidences strongly support this line of argument. One is that Hong

5 For this line of argument see Chen T. J. et al. (1995) ‘Taiwan’s Outward Direct Investment: Has Domestic Investment been Hollowed Out?’ recollected in Robert Ash and Anne Booth (2000) The Economies of Asia 1950-1998: Critical Perspectives on the , Volume 3, The Four Tigers, and New York, Routledge, pp 479-496. 6 For an earlier account of the Hong Kong model and the role played by the trading firms, see James Riedel (1974) The Industrialization of Hong Kong, Kiel: Institut fur Weltwirtschaft an der Universitat Kiel, pp. 22-23. 7 This production system in Hong Kong is classified as the ‘buyers-driven commodity chain’ as its manufacturing production was largely OEM (original equipment manufacturing) based upon orders , via trading firms, from foreign giant buyers. For details of this mechanism see Gary Gereffi and Miguel Korzeniewicz (1994) (eds.) Commodity Chains and Global Capitalism, Westport, Connecticut: Greenwood Press, and IDS Bulletin, Special Issue on Value Chain Theories, Vol. 32, No. 3. 8 For negative views on Hong Kong’s industrial development see Stephen Chiu et al. (1997) City-States in the Global Economy: Industrial Restructuring in Hong Kong and Singapore, Westview Press; and Stephen Chiu and Wong Ka-chung (2001) ‘Growth without Catching Up: Organizational Dynamics in the Restructuring of the Electronics Industry in Hong Kong,’ Hong Kong Institute of Asia-Pacific Studies Occasional Paper, No. 115.. Kong has the lowest R&D9 efforts in the region. Another is that Hong Kong never established heavy and chemical industries as in Singapore, Taiwan and South Korea. Its industrial structure seriously skewed towards light consumer industries processing (1) raw materials and (2) intermediates with (3) capital machinery – all three elements were mainly imported from abroad10. Hence the intra-industry linkage was inherently low – this not only prevailed amongst the manufacturing firms in Hong Kong before the emergence of Greater China, but also extended to the relocated and Hong Kong-based firms.

By contrast, Taiwan had established a much broader industrial base and thus the intra-industry linkage was strong between the relocated and Taiwan-based firms/industries – as reflected in the enormous trade surpluses that Taiwan enjoyed vis-à-vis the Mainland. As illuminated by Table 10, in the mid 1980s the heavy industry has accounted for almost half of total industrial output in Taiwan. From the late 1980s onwards, the exodus of light industries has, hollowing-out effect notwithstanding, two main effects on Taiwan’s industrial structure. One is that it forced Taiwan-based firms/industries to restructure towards capital- and technology-industries. Second is that through the intra-industry linkage the success of the relocated firms/industries in the Mainland would in turn increase their demands for capital goods and intermediates from the home-based firms/industries. In combination, they accelerated the process of Taiwan’s industrial upgrading, though inevitably with the transitional problems common to those in Hong Kong.

In Search for Deeper Determinants: The Political Economy and Historical Legacy

Hong Kong

9 In terms of R&D efforts, Hong Kong lagged far behind its East Asian counterparts and also the Mainland. For example, in 1994 the ratio of R&D expenditure to GDP in Hong Kong was a meager 0.1 per cent, while that of South Korea, Taiwan and Singapore was 2.29 per cent, 1.80 per cent and 1.18 per cent respectively. Even that of China far exceeded Hong Kong by 0.5 per cent in the same year (see Suzanne Berger and Richard K. Lester (eds.) (1997) Made by Hong Kong, New York: Oxford University, Table 6.2) Berger, Peter and Machael Hsin-hung Hsiao (1987) (eds.) In Search of an East Asian Development Model, New Brunswick, NJ and London: Transaction. 10 In Hong Kong, the export-output ratio was as high as 90 percent in the 1960s. Another survey shows Lin et al. (1980: ch.6) show that in 1964-74 for the overall manufacturing in Hong Kong the indirect employment creation amount was as low as less than 11 per cent of the direct labour requirements, meaning 89 per cent of employment was directly generated by exports, and Hong Kong’s domestic intermediate inputs accounted for only 23 per cent of total output (see Lin, Tzong-biau, Victor Mok and Yin-ping Ho (1980) Manufactured Exports and , Hong Kong: The Chinese University Press.) These indicators collectively show that the intra-industry linkage within the manufacturing sector in Hong Kong was indeed very low. The foregoing discussion points out that the original industrial base in the home economy plays a central role in determining the economic outcome of the cross-border integration. Hence a fundamental question is: what have prevented Hong Kong from establishing its heavy and high-technology industries? Official answers - such as limited economies of scale, free port status, financial centre etc. - are found not convincing when experiences of its parallel, Singapore, are considered. An in-depth look at that the unique political economy of Hong Kong is needed.

From the commencement of its colonization in the 1840s, for the British Empire Hong Kong’s raison d’être had been an outpost in particular of commercial interests in . By the early twentieth century Hong Kong had ascended to a financial and commercial hub in the region. Thanks to the Civil War and the political unrest in Southeast Asia in the late 1940s, the free port status of Hong Kong became the prime haven of capital flight, entrepreneurs and Chinese refugee (estimated to be around 500,000-600,000) which proved invaluable when the embargo was enforced upon Hong Kong in 1952. The then ‘dying city’ was soon regalvanized when the industrialization was quickly initiated by refugee entrepreneurs (in particular those from ). Coupled with a favourable external world economy, within a decade the industrialization was more or less completed – without the heavy hand from the government, and by 1961 the full employment was achieved.

From a comparative perspective, in the postwar era Hong Kong was the first economy whose manufacturing production was strongly export-orientated. It also attracted the first wave of FDI (foreign installations of the electronics companies from the US and Japan in the late 1950s), and thus dubbed as the first mover in the new international division of labour, thereby securing a lead for at least 10-15 years to the rest three ‘Tigers’. Parallel to the stunning performance of the manufacturing sector was the rise of its financial sector to the status of international financial centre from the late 1960s onwards. While the manufacturing sector was by and large in the Chinese hands, the commercial and financial sectors still remained the stronghold of foreign expatriates. This dualistic structure had far-reaching impacts on Hong Kong’s industrial development.

First, it created a strong division between industrial and financial capitals in Hong Kong. Some observers point out that throughout the past decades the bulk of Hong Kong’s manufacturing’s was self-financed11. Non-financial enterprises were

11 Victor F. S. Sit (1982) ‘Dynamism in Small Industries – The Case of Hong Kong,’ Asian Survey, Vol. 22, No. 4 (Apr.), pp. 399-409; Bernard, Andrew B. and Mary Hallward-Driemeier (1997) ‘Capital starved of external finance while Hong Kong being an international financial centre was awashed with massive capital flows. Concealed in the irony was the operational logic of global finance12 which has meager interest in long-term investment but is active in speculative activities. It deserves stating that the relationship between industrial and financial capitals in Hong Kong mirrored that of between the City of London and the British economy13. The overlapping force between these two cases was the British banking force whose utmost doctrine is ‘borrowing short and lending short,’ regardless of the need of longer-run investment in industrial development. For example, in 1980 when the manufacturing of Hong Kong still accounted for 23.7 per cent of GDP, its share of total loans was disproportionately only 7.2 per cent14. This irony in Hong Kong lasts to the present day and even more ‘surprisingly, the financial structure of large companies is very similar to that of smaller, start-up firms. There is still a heavy reliance on internal financing or short-term loans.’15 Although conventional wisdom of financial development has that ‘countries with larger and more active stock markets grow faster over subsequent decades... Industries and firms that rely heavily on external finance grow disproportionately faster in countries with well-developed banks and securities markets than in countries with poorly developed financial systems,’16 the case of Hong Kong throws more, but often ignored, nuances on the relationship between financial and industrial capitals - i.e. given being placed in a well-established financial environment, industries and firms are not guaranteed to have better access to external finance. In short, the relationship between financial and industrial capitals can not be taken for granted. The case of Taiwan will, as we shall see later, shed more light on this issue.

Ｔhe Role of the Colonial State and the State-Business Relationship

Markets in Hong Kong,’ in Suzanne Berger and Richard K. Lester (eds.) ibid., pp. 293-319. 12 For the formation of international financial centre and the movement of global financial capitalism see Xabier Gorostiaga (1984) The Role of the International Financial Centres in Underdeveloped Countries, London and Sydney, Croom Helm; Charles Kindleburger (1993) A Financial History of Western Europe (Second Edition), New York and Oxford: Oxford University Press. 13 For articulations on the City and the British political economy see P. J. Cain and A. G. Hopkins (2002) British Imperialism: 1688-2000 (Second Edition), Edinburgh and London: Pearson Limited.; Geoffrey Ingham (1984) Capitalism Divided? The City and Industry in British Social Development, London: Macmillan; (Great Britain) (1982) The City: A Socialist Approach (Report of the Labour Party Financial Institutions Study Group), London: Labour Party; Jerry Coakley and Laurence Harris (1983) The City of Capital: London’s Role as a Financial Centre, London: Basil Blackwell. 14 By contrast, in Taiwan the corresponding figures, in 1984 ,were 37.5 per cent and 38.8 per cent. . In the viewpoint of Tuan and Ng, the development of Hong Kong’s financial sector had a crowded-out effect on its industrial development, see Chyau Tuan and Linda F. Y. Ng (1998) ‘Regionalization of the Financial Market and the Manufacturing Evolution in Hong Kong: Contributions and Significance,’ in Journal of Asian Economics, Vol. 9, No. 1, pp. 119-137. 15 Bernard, Andrew B. and Mary Hallward-Driemeier, ibid., p. 302. 16 Ross Levine (1997) ‘Financial Development and Economic Growth: Views and Agenda,’ in Journal of Economic Literature, Vol. ⅩⅩⅩⅤ (June), pp. 688-726.

From the foregoing reviews, there are at least two market failures that the Hong Kong government was not well placed to tackle. One concerns R&D inputs and the other is the channelling between financial and industrial capitals. Both have strong external economies that require government’s coordination in order to bridge the gap between societal and private benefits; both are highly relevant for a latecomer to catch up in terms of national competitiveness.

At the very superficial level, these jobs, if not responsibilities, were shunned away by the official slogans – i.e. non-intervention and laissez-fairism. A closer look into its history unveils the underlying political economy of the ideological anachronism. First, the acquisition of Hong Kong was largely motivated and assisted by British merchants who had long engaged in the south China trade. Thenceforth the political power in Hong Kong was shared between the colonial state and the commercial interests of British expatriates - giving rise to a widespread belief that the previous Crown colony was ‘ruled by Jardine’s, the Jocky Club, the Hong Kong and Shanghai Bank and the Governor, in that order of importance.’17 Although Hong Kong’s economic thrust shifted towards industrial activities after the 1950s, the power structure remained largely unchanged. ‘[A]t the Exco level, where Government and the economic elite fused, the ideology and interests of traders, bankers, and those for whom manufacturing was a relatively peripheral source of profit, prevailed. For most of this group, whatever the previous focus of their , property development was becoming the central activity… It was this power structure that rejected calls for assisted industrial upgrading and a new chapter in technology policy, even on the smallest scale.’18

Hence, the ‘barren-rock-turned-capitalist-paradise’ story in Hong Kong is overthrown when historical episodes, politics and the state-business relationship are brought into light19. Moreover, coupled with political uncertainty of the previous colony – which was subtly captured by the well-known phrase of ‘the borrowed place, the borrowed time’, these factors in combination, as illustrated in Figure 3, forged a collective mindset of short-termism deeply entrenched in the Hong Kong society. As a result, the

17 Quoted from Crisswell, Colin N. (1981) The Taipans: Hong Kong’s Merchant Princes, Hong Kong: Oxford University Press, p222. 18 Quoted from Christopher Howe (1996) ‘Hong Kong’s Reversion to China: The Political, Administrative and Economic Dimensions,’ in Robert Ash and Anne Booth (eds.) The Economies of Asia 1950-1998 Volume Ⅲ: The Four Tigers, London and New York: Routledge, pp. 186. 19 A systematic reversal of the mainstream account of Hong Kong’s economic miracle see Stephen Chiu (1994), ibid. This line of argument is culminated in Ngo Tak-Wing (ed.) (1999) Hong Kong’s History: State and Society under Colonial Rule, Routledge: London and New York needed commitments - both from the government and the private sector - to the long-term industrial development were overruled in Hong Kong 20 , thereby for decades its industrial structure remaining narrow and its industrial capability unsophisticated. After the emergence of Greater China, the intra-industry linkage between Hong Kong and China was low indeed and over time Hong Kong’s manufacturing sector was hollowed out.

Taiwan

Colonial Legacy and the Postwar Dualistic Economic Structure

It is widely perceived that the infrastructure in Taiwan was by and large laid down during the Japanese colonization21. The industrialization of Taiwan was initiated from the 1930s in order to match the then Japanese military needs in the Pacific War. In the immediate postwar years the Japanese-owned, national and private, facilities were taken over by the KMT regime which became the huge public sector – the state-owned enterprises (SOEs), monopolising the commanding height of the economy. In 1952, the scale of the SOEs accounted for as high as 57.3 per cent of total industrial output. Although thereafter its share was in a consistent decline and within this group inefficiency and corruption were often seriously criticized, it became the milestone for Taiwan to develop into heavy- and chemical industries in the 1970s. Moreover, for decades until the early 1990s all the financial institutions were directly controlled by the government. Thus, from the commencement of the KMT era in Taiwan, the government itself was the combination of (1) a significant industrial force comprising all monopolistic enterprises in capital-intensive industries whose scale accounted for more than half of total industrial output; (2) a monopolistic financial capital; (3) the biggest landlord occupying around one fifth of arable land and (4) an authoritarian politics. This mixture of the Japanese legacy and Nationalist remnants of the Mainland experiences forged a national capitalism in Taiwan wherein the state enjoyed unchallenged power based largely upon the monopoly economics. Therefore from the very start, unlike its counterpart in Hong Kong, the Taiwanese authorities had plenty of tools, if not resources, to manoeuvre its development plans.

The biggest agenda for the then KMT regime in Taiwan was to repair the war wrecked

20 The setting up of central bank, industrial bank and industrial sites were once put onto the agenda but all overruled by the power structure of Hong Kong. 21 The infrastructure laid down by the Japanese was by and large sufficient to the postwar needs until the late 1960s, see Dwain Chen-Pu (ed.) (1990) The Postwar Economy in Taiwan, : Zen-jen (in Chinese), p.124. economy. Shortage of foreign reserves was urgent. Thanks to the outbreak of Korea War in 1950 for which changed the US policy towards the KMT regime, in economic realm the enormous US aid in the period of 1952-65 with an average US$1,00 million per annum, equivalent to 5 -10 per cent of GNP22, not only helped the KMT regime consolidation, but also contributed to the capital formation in Taiwan, thereby rooting the significant US influence in the policy-making of Taiwan. One of the examples was the setting-up of export processing zones (EPZs) in 1966 in order to facilitate the global expansion of the US corporates in Taiwan. Thereafter, exports of manufactured goods took off and for the first time surpassed agriculture-related exports. Between 1966 and the first oil shock in 1973, the manufactured exports expanded rapidly by 33 per cent per annum, reflecting a new chapter of export-driven growth in the Taiwan economy. In 1976, the persistent trade deficits turned surplus for the first time and thereafter a large foreign reserves were being accumulated. Based upon this fortune, the government was better equipped to advance into heavy- and chemical industries by initiating the 10 Major Constructions, thereby a much broader industrial base was established.

In this a more fundamental change is that by the local content requirement there occurred a backward linkage between the foreign companies in EPZs and Taiwanese SMEs. This linkage created invaluable technology spillover effects, which were essential for Taiwan’s stepping into IT industries in the 1980s. In this an essential step was to institutionalize technology deepening through the establishment of Industrial Technology Research Institute (ITRI) in 1973 as a cardinal R&D centre, spreading the unaffordable high cost (for SMEs) as well as R&D fruits as the hub in the national innovation system23 in Taiwan. This R&D mechanism was further enhanced and fruits were better applied by the establishment of Hsinchu Science and Industry Park in 1979, thereby fostering a competitive local high-tech industry, marking a cornerstone of Taiwan’s technological development and a shift away from dependence on traditional labor-intensive industries.

Similar to Hong Kong, the mainstay of the Taiwan’s manufacturing sector was

22 The aid totaled to US$1.5 billion (more than 30 per cent of domestic investment annually) form 1951 to1965, 67 per cent and 6 per cent of which were received by the public sector and the private sector respectively (see Wei bin Zhang (2003) Taiwan’s Modernization: Americanization and Modernizing Confucian Manifestations, Singapore: World Scientific Publishing Co.Pte.Ltd, pp. 150-52). 23 In the school of Neo-Schumpeterianism which focuses upon the technology factor in economic development, ‘national innovation system’ is a set of distinct institutions jointly and individually contributing to the development and diffusion of new technologies and providing a framework within which the government forms and implements policies to influence the innovation process. In this a major work of cross-national comparison see Richard R. Nelson (ed.) (1993) National Innovation Systems: A Comparative Analysis, New York and Oxford: Oxford University Press. composed by numerous SMEs. Their features - such as ‘Chineseness’, familism and the accompanying flexibility and dynamism etc. – are elements of the East Asian miracle. Whilst SMEs were marginalized by the business-state alliance in Hong Kong, however, sufficient attention and assistances were paid, by the government, to their counterparts in Taiwan. For example, industrial parks and access to external finance were provided at lower cost, R&D risks shouldered, coordination provided - these were embarked on with a view to helping SMEs (1) overcome their size constraints by networking with large corporates and (2) advance into the explosive IT market. These efforts are evident in that from the 1980s there has been dynamic changes taking place in the market structure of Taiwan, as reflected in, first, the rising ratio of the top 100 corporates’ revenues to GNP (from 28 per cent in 1975 to 54 per cent in 199824), and second, an increasing share of exports being taken by large corporates (from 32 per cent in 1981 to 51 per cent in 199725). These assistances from the government, by contrast, were all denied in Hong Kong.

Summary

The ’s industrial development tells two things: one is that industrial lead (than other countries) can be temporary; second is that FDI are footloose and spillover effects from them are not guaranteed. In a highly competitive environment of world economy, especially from the stance of late comers, it requires a skillful coordinator, often played by the government, orchestrating essential elements (especially of external finance and R&D) in order to achieve a sustainable institution responsive enough to meet unexpected challenges of the external world. In terms of industrial policy, given the persistently passive stance of the colonial state during the 150-year colonization, thanks to the , the manufacturing sector in Hong Kong did have a strong chance but later lost it because the intra-firm and intra-industry linkages were weak in the Hong Kong-China linkage. Therefore its comparative advantage vis-à-vis the Mainland lies in the tourism and . The entrepôt activities were resumed but soon declined since the harbor infrastructures in the Mainland were rapidly catching up. Thus the narrowing industrial base has made Hong Kong more susceptible to external shocks - as evidenced by the Financial Crisis in 1997-98 and the SAR epidemic in 2003. In the longer term, the prosperity of Hong Kong would largely hinge on patronage policies from Beijin, of which Closer Economic Partnership Arrangement (CPEA) and the

24 See Table 3-1 in Wan-wen Chu (2003) The Taiwan Economy under the Globalization, Taiwan: A Radical Quarterly in Social Studies, Research Series 11 (in Chinese). 25 See Ministry of Economic Affairs (Taiwan), White Paper on Small- and Median-size Enterprises in Taiwan 1998. are two measures of importance in reenergizing Hong Kong’s stagnant economy. CEPA came into force in the beginning of 2004 with two main measures, being the first formalized institution of economic integration within Greater China. One measure is aiming at promoting domestic exports from Hong Kong into the Mainland by granting preferential treatment of zero tariffs. The other is to provide lower thresholds and easier entry permits for FDI of the service industries from Hong Kong in the Mainland. The effect of the latter is expected to be larger, but would have limited repercussion on Hong Kong’s domestic economy. In this regard, the policy of Individual Visit Scheme, also introduced in 2004, has demonstrated its immediate effects in boosting Hong Kong’s tourism. Under the scheme, four million visits by Mainlanders were created, accounting for one-third of total Mainlander visits and 19 per cent of total visits in the year.

As in the cross-Strait linkage, most analysts agree that to what extent that the Taiwan economy can benefit will largely hinge on the speed of industrial upgrading on the islands. In order to maintain the lead, FDI outflows to the Mainland, especially of those ‘core industries’, are still being censored. The trade surpluses that Taiwan currently enjoys vis-à-vis China are also artificial ones since an equally bilateral trade partnership has not been established across the Strait. The rapid catching up of the Mainland, the problem of excessive capacity and the political uncertainty in combination cast long deep shadows over Taiwan’s economic prospect. A brighter sign is that Taiwan’s technological dependence on Japan, reflecting in high trade deficits vis-à-vis the latter, has shown a decreasing trend26.

Turn to the theory of economic integration. The demise of Hong Kong’s manufacturing industries evidences that static gains from economic complementarity can be exhausted in short term. In the highly competitive environment of world economy, it is the dynamic gains - i.e. the promotion of productivity - that matter for a sustainable development, which demands systematic efforts and long-term cultivations of agents at all levels, including government policy, corporate strategies, financial support, educational system, and etc., in a highly coordinative manner. #

26 The proportion of high-tech imports to total imports dropped from around 60 per cent in the early 1980s to around 50 per cent in the late 1990s, a significant proportion were from Japan. Appendix: Tables and Figures

Table 1. Labour Costs in the Manufacturing of Selected Economies in 1987 Average Hourly Earnings in

Manufacturing (US$) US 13.46 Japan 11.34 Hong Kong 2.11 Taiwan 2.33 South 1.69 Korea Singapore 2.37 China 0.37 Source: Knox and Agnew (1994: 336)

Table 2 China's Main FDI Sources (in Utilized term) 1985-2002 US$mn. World Hong Kong Taiwan+ Japan A B B/A C C/A D D/A E E/A 1985 1,956 956 48.9% na na 357 18.3% 315 16.1% 1989 3,393 2,037 60.0% 155 4.6% 284 8.4% 356 10.5% 1992 11,008 7,507 68.2% 1,055 9.6% 511 4.6% 710 6.4% 1998 45,463 18,508 40.7% 7,271 16.0% 3,898 8.6% 3,400 7.5% 2002 52,743 17,861 33.9% 11,268 21.4% 5,424 10.3% 4,190 7.9% Total 443,749 203,003 45.7% 61,302 13.8% 39,425 8.9% 35,732 8.1% Note: Taiwan+: these figures are adjusted by summing together three registered FDI sources (Taiwan, the British Virgin Island and Cayman Island) in the PRC official data. Source: China's Statistical Yearbook and Almanac of China's Foreign Economic Relations and Trade, various issues.

Table 3. Degrees of 'Mainlandization' of the Top Four Investors in China %

Hong Kong Taiwan + United States Japan

CHDI/GDP CHDI/K CHDI/GDP CHDI/K CHDI/GDP CHDI/K CHDI/GDP CHDI/K 1985 2.86 13.03 na na 0.01 0.04 0.02 0.08 1989 3.04 11.68 na na 0.01 0.03 0.01 0.04 1992 7.45 27.18 0.50 2.08 0.01 0.05 0.02 0.06 1998 11.38 37.62 2.72 11.13 0.04 0.21 0.09 0.33 1999 10.34 40.12 1.96 8.33 0.05 0.22 0.07 0.26 2000 9.53 36.29 2.18 9.83 0.04 0.21 0.06 0.24 Mean Value 7.43 27.65 1.84 7.84 0.03 0.13 0.04 0.17 Note: 1. CHDI/GDP: ratio of FDI outflows to China to the home economy's GDP; 2. CHDI/K: ration of FDI outflows to China to the home economy's domestic capital formation; Source: 1. CHDI: Table 1-2; 2 GDP: Quarterly National Economic Trends (Taiwan) Aug. 2001, p. 41 and 45.; 3. Taiwan's "gross fixed capital formation" in Quarterly National Economic Trends Taiwan Area, The Republic of China Issues 88 (Feb. 2000, p.9) and 97 (May, 2002, p. 9); Hong Kong's "gross fixed capital formation" in Hong Kong GDP 2001 (Hong Kong), p. 12; as those of the US and Japan are indirectly from Quarterly National Economic Trends (Taiwan) Aug. 2001, p. 49.

Table 4. Changes of the Manufacturing in Small Matured Economies and NIEs in 1980-2002 GDP Per Population Manufacturing Share in Capita (millions) GDP (%) (US$) 2003 2003 1980 2002 Change Hong Kong 7.0 22618 22.2 4.4 -17.8 Singapore 4.3 21195 29.1 26.5 -2.6 5.4 39497 16.8 15.1 -1.7 Finland 5.2 31069 25.1 20.9 -4.2 4.5 48880 14.4 9.8 -4.6 8.9 33925 20.2 18.2 -2.0 7.2 43486 27.9 23.0 -4.9 Taiwan 22.6 12669 36.0 25.9 -10.1 South Korea 47.7 11059 28.2 29.2 1.0 Source: United Nations, UNCTAD Handbook of Statistics 2004 (on-line database).

Table 5. Long-run Economic Growth of NIEs 1970-2003 1970-80 1980-89 1990-03 1995-03 2001 2002 2003 Per capita real product (%) Hong Kong 6.0 5.7 1.8 1.0 -0.9 1.1 0.5 Taiwan 8.6 10.8 1.9 -0.2 -10.2 0.7 2.2 South Korea 6.3 7.6 4.7 3.9 2.4 5.7 2.5 Singapore 6.8 4.0 3.4 1.3 -4.5 0.3 -1.2 Total real product (%) Hong Kong 8.8 7.1 3.6 2.7 0.5 2.3 1.5 Taiwan 10.7 12.4 2.7 0.5 -9.6 1.3 2.5 South Korea 8.2 8.9 5.5 4.7 3.1 6.3 3.1 Singapore 8.4 6.3 6.2 3.9 -2.4 2.2 0.5 Source: United Nations, UNCTAD Handbook of Statistics 2004 (on-line database).

Table 6. Unemployment Rate for the Four Little Dragons in Selected Years % Hong Kong Taiwan South Korea Singapore 1971 - 1.7 4.5 4.8 1981 3.9 1.4 4.6 2.9 1998 4.7 2.7 7.0 3.2 2002 7.3 5.2 3.1 4.4 2003 7.9 5.0 - 4.7 Source: Directorate-General of Budget (Accounting and Statisitcs, Executive Yuan, Taiwan), Quarterly National Economics Trends, various issues.

Table 7. Changes in Hong Kong's Merchandise Trade Structure 1980-2003 HK$mn., % 1980 1985 1990 1995 2000 2003 Hong Kong's global trade Total exports (Xw) 98244 235152 639874 1344127 1572689 1742436 Domestic exports (DXw) 68172 129882 225875 231657 180967 121687 Re-exports (RXw) 30072 105270 413999 1112470 1391722 1620749 Total imports (Mw) 111651 231420 642530 1491121 1657962 1805770 DXw/Xw 69.4 55.2 35.3 17.2 11.5 7.0 RXw/Xw 30.6 44.8 64.7 82.8 88.5 93.0 RXw/DXw 44.1 81.1 183.3 480.2 769.0 1331.9 Hong Kong's trade vis-à-vis China Total exports (Xc) 6247 61212 158378 445293 542981 744917 Domestic exports (DXc) 1605 15189 47470 61250 54438 39130 Re-exports* (RXc) 4642 46023 110908 384043 488823 705787 Total imports (Mc) 21948 58963 236134 539480 714987 785625 DXc/Xc 25.7 24.8 30.0 13.8 10.0 5.3 RXc/Xc 74.3 75.2 70.0 86.2 90.0 94.7 RXc/DXc 289.2 303.0 233.6 627.0 897.9 1803.7 Hong Kong's trade vis-à-vis China relative to its global trade DXc/DXw 2.4 11.7 21.0 26.4 30.1 32.2 RXc/RXw 15.4 43.7 26.8 34.5 35.1 43.5 Mc/Mw 19.7 25.5 36.8 36.2 43.1 43.5 Note: * Destination. Source: Census and Statistics Department, Hong Kong, Hong Kong Annual Digest of Statistics, various issues.

Table 8. Average Annual Growth Rate of Hong Kog's Merchdandise Trade 1980-2003 % 1980-85 1985-90 1990-95 1995-00 2000-03 Hong Kong's global trade Total exports 19.1 22.2 16.0 3.2 3.5 Domestic exports 13.8 11.7 0.5 -4.8 -12.4 Re-exports 28.5 31.5 21.9 4.6 5.2 Total imports 15.7 22.7 18.3 2.1 2.9 Hong Kong's trade vis-à-vis China Total exports 57.8 20.9 23.0 4.0 11.1 Domestic exports 56.8 25.6 5.2 -2.3 -10.4

Re-exports (Destination) 58.2 19.2 28.2 4.9 13.0

Total imports 21.9 32.0 18.0 5.8 3.2 Source: Census and Statistics Department, Hong Kong, Hong Kong Annual Digest of Statistics, various issues.

Table 9. Average Annual Growth Rate of Taiwan's Major Exports Markets % Total China US Japan 1985-90 16.9 34.8 8.0 19.2 1990-95 10.7 34.6 4.0 9.6 1995-00 5.8 5.2 5.7 4.8 2000-03 -0.9 12.2 -9.3 -10.5 Source: Taiwan Statistical Data Book 2004; On-line Database.

60.0

50.0

40.0

% 30.0 China

20.0 US

10.0 Japan

0.0 1985 1990 1995 2000 2003

Source: Taiwan Statistical Data Book; Mainland Affair Council On-line database.

Figure 1. Structural Change of Taiwan's Export Destination 1985-2003

25.0

20.0

15.0 %

10.0

5.0

0.0 1990 1995 1999 2000 1990 1995 1999 2000 1990 1995 1999 2000 1990 1995 1999 2000 1990 1995 1999 2000 1990 1995 1999 2000 1990 1995 1999 2000 1990 1995 1999 2000 1990 1995 1999 2000 1990 1995 1999 2000 Japan China Hong Taiwan South Singapore Kong Korea

Source: Chi-jen Wu, forthcoming. Electronics cluster Other High-techs

Figure 2. World Shares of East Asian Countries in High-tech Exports 1990-2000

Table 10. Indicators of Taiwan's Industrial Upgrading 1985-2004

Heavy, Chemical and Labour Heavy Industry Tech-intensive Industries Productivity*

Year % of total % of total (at constant Output industrial Exports manufacturing price of 1996) output exports (US$bn.) (％) (US$bn.) (％) (US$) 1985 378.8 46.9 163.5 53.2 10752 1990 890.3 54.3 402.8 59.9 22815 1995 1564.7 65.2 750.6 69.9 32053 2000 1928.5 75.1 1153.9 79.0 33503 2004 2620.0 80.8 1434.6 83.8 37236 Note: *: real industrial output divided by the number of industrial employment. Source: Website of Ministry of Economic Affair (MOEA), ROC.