Introduction

In his third Policy Address, the Hong Kong Special Administrative Region (SAR) Chief Executive Tung Chee Hwa expressed his desire to build Hong Kong to become a world-class, cosmopolitan city comparable to New York and London. This vision has stimulated much discussion, and has received general approval of the local community.

New York and London are viewed as the prototype of world cities, which are often characterized as: 1) the centrality of finance and international transactions; 2) clustering of producer services; 3) the rise of international banking and producer services and the shrinkage of manufacturing sector; 4) centralized transnational corporations' command and co-ordination; 5) strong ability to attract global investments; 6) a cosmopolitan culture and consumerist ideology. Under these criteria of world city, Hong Kong, possessing some of these features but lacking of others, is considered to be not in the same rank as New York and London within the hierarchy of world cities.

However, the developmental process towards a first-tier world city will not be easy. In order to upgrade the ranking of Hong Kong in the hierarchy of world cities, it should first move up the value-added ladder and improve market efficiency through more deregulation and competition. However, along these paths, we will encounter some fundamental challenges, which were experienced by New York and London in the 1980s. First, in both New York and London, the loss in manufacturing jobs has caused persistently high unemployment rates. Moreover, the emergence of international finance and producer services in these cities has been accompanied by the waves of privatization and deregulation in the 1980s. These economic restructurings further exacerbated the unemployment situation. Second, the increasing demand for knowledge intensive labour and decreasing demand for lower skilled workers resulted in widening the gap in wealth distribution. Third, some world cities tend to go through a period of fiscal crisis, which forced their governments to cut civil services and jobs. New York and Tokyo had severe fiscal crises in the mid-1970s, while the fiscal problem in London was in the form of a protracted shrinkage in the size of the government¹. These are what we called "world-city syndromes", and we expect Hong Kong to encounter these challenges as it is developing in the same direction to become a first-tier world city.

The Economic Transformations in New York and London

In New York and London, the emergence of international banking and producer services began to take over manufacturing as the engines of economic growth between 1977 and 1985. During this period, the shares of manufacturing jobs in total employment fell from 21.9 percent to 15.2 percent in New York and from 22 percent to 16 percent in London, while the shares of service jobs in total employment rose from 63.7 percent to 73.8 percent in New York and from 73.0 percent to 78.5 percent in London.

Alongside, there were also pronounced losses of overall employment levels, as service sectors could not immediately absorb all workers released from manufacturing sectors. Between 1977 and 1985, the absolute levels of employment in New York merely increased by 5.5 percent and declined by 4.8 percent in London. In addition, fiscal situations deteriorated sharply, as tax revenues declined as a result of the massive departure of manufacturing headquarters and the related office jobs. This, in turn, forced these governments to cut expenditure through privatization of their services and assets, and slashed staffs' payrolls that further exacerbated the overall unemployment situation. As New York and London went on to become world-class financial centres, more jobs were created in the higher ends^2.

The Economic Transformation in Hong Kong

Hong Kong began its economic transition two decades ago when manufacturing activities moved across the border after the Mainland opened up its door to foreign investment. The share of manufacturing jobs in total employment dropped from 38.4 percent in 1980 to 14.1 percent in 1997. On the other hand, the Mainland factories required considerable producer services, such as legal affairs, finance, accounting, public relations, advertising and insurance, etc. As a result, the level of employment in service sectors increased from 45.1 percent in 1980 to 64.2 percent in 1997. However, Hong Kong did not undergo the sort of adjustment pains (namely high unemployment rates and fiscal crisis) experienced by the US and the UK in the 1980s. In fact, the absolute level of employment in Hong Kong managed to rise by 38.4 percent between 1980 and 1997, and the Government's fiscal surplus increased from HK$ 6.7 billion in 1980/81 to HK$ 86.8 billion in 1997/98.

Two factors lay behind this apparently smooth economic transformation. First, China's open door policy, which started in the late 1970s, did more than divert manufacturing from Hong Kong. It greatly accelerated trade flows between China and the world, giving Hong Kong an important new role of re-exporting Chinese goods and providing supporting services. Hong Kong's re-export trade registered double-digit growth rates for 17 out of 18 years between 1978 and 1995. This diverted labour away from factory, and created a wealth effect that increased demand for assets. Moreover, an artificial shortage of residential and commercial properties, fuelled asset prices and boosted the property market and related construction sectors. The subsequent economic bubble spurred private consumption and created extraordinary demand for retail and service sectors. This increased employment in the service sectors that more than offset the decline in the manufacturing sectors.

Blown off of the Facade

When the asset bubble and China trade deflated simultaneously during the Asian crisis, the adjustment pains stemmed from the structural shift from manufacturing to service-based economy began to creep.

As China trade slumped following the decline in other Asian markets, Hong Kong's re-export performance reversed dramatically, going from positive growth of 4.2 percent in the third quarter of 1997 to a contraction of 6.6 percent in the third quarter of 1998. The property sector and private consumption shrank significantly. The unemployment rates of service workers and retail sales employees rose from 2.8 percent to 6.2 percent during the same period, while the unemployment rate in the construction sector surged from 2.4 percent to 9.0 percent.

The downturns in trade and service sectors also exposed the problems of the Government's fiscal condition. Lower corporate earnings, higher unemployment rate, and downward adjustment in individual income led to a serious contraction in Government's revenues. In addition, slumps in property sectors depressed the share of property-related incomes in total Government revenues from 35 percent in 1996/97 to about 15 percent in 1998/99.

On the other hand, all the social goodies that were promulgated during the economic prosperity continued to dig into the SAR Government's coffers. These together with the spending on stimulus measures during the recession attributed to the fiscal deficit of HK$ 23.2 billion in fiscal year 1998/99. According to the Government estimates, the fiscal deficit is likely to increase to about HK$ 36.5 billion in 1999/2000 and HK$ 5.6 billion in 2000/2001. Without the facade of wealth from asset bubble, and the support of a strong re-export activities, Hong Kong looks little better than New York or London in the early days of their restructurings.

Syndrome 1: Higher Unemployment Rates

Unemployment rates for lower skilled workers would become persistently high, as the Territory is undergoing economic restructuring after the Asian crisis. First, the SAR Government is improving market efficiency by deregulating various sectors, notably telecommunications and banking. However, there are rooms for far more deregulation and competition in such areas as aviation industry and utilities, not to mention privatization and outsourcing of government activities. Such a trend will generate greater competition, mergers and acquisitions, and a leaner, more efficient private sector. As a result, there would inevitably be more job cuts, and an increasing emphasis on higher value-added activities performed by highly skilled labour. 

Second, the SAR Government wants to encourage development of knowledge-intensive economic sectors, such as information technology, Chinese medicine and fashion design. These involve jobs for professionals and specialists. Moreover, the continued development of e-businesses will reduce Hong Kong's advantage as a location for lower-end business services. For example, trading support, clerical and accounting works could be outsourced to lower cost locations. This implies a further decline in job opportunities for lower skilled workers.

Third, China's membership of the World Trade Organisation ("WTO") will lead to more direct trade between China and the world. This will reduce re-export businesses and spur relocation of low value re-export jobs to the Mainland. The re-export activities that remain in Hong Kong will rely increasingly on information technology and improved productivity. Less-skilled Hong Kong workers are likely to find themselves difficult to fit into the new demand of the economy. This would also widen the social disparity when Hong Kong moves up the hierarchy of world cities.

Syndrome 2: Growing Social Disparity

A sophisticated service-based economy requires a highly skilled workforce, as we see from the high salaries commanded by financial, legal, technology and other professionals in New York and London. While the poor may not get poorer, the rich certainly become richer. Unless the lower skilled workers upgrade their skill levels, social disparity would be widened.

The Asian crisis undoubtedly widened the income gap in Hong Kong. The median monthly income for professionals rose from HK$ 28,000 in the second quarter of 1997 to about HK$ 30,000 in the second quarter of 1999, while salaries for workers in the elementary occupations³ declined from HK$ 6,000 to HK$ 5,500. As the economic transition continues, more lower skilled workers are expected to fall into longer-term unemployment and their livelihood continues to worsen. This raises the prospect of a more polarized society in Hong Kong. As a solution, some would suggest an uplift of social safety net to narrow the gap. However, the current fiscal deficit, as mentioned above, makes it questionable as to how much room in the fiscal budget can the Government make available for an expansion of social safety net. The widening social disparity may be unwanted, but it is likely to co-exist with the development of world cities like New York and London.

Syndrome 3: Budget Deficit

As the economy is steering away from property-based development, it is unlikely (and undesirable) that the SAR Government will be able to rely on property-related incomes for about 35 percent of its total revenues, as it did before the crisis. Not to mention that China's accession to the WTO would cause more shrinkage in tax base due to the relocation of re-export activities to China. Indeed, the current budget deficit could be seen as a structural problem.

Currently, the Government's "slimming" plans include: 1) privatization of some government services, such as water supply; 2) outsourcing social welfare services; 3) selling a minority part of its shares in the Mass Transit Railway Corporation; 4) cutting civil servants' starting salaries by about 6.0 to 31.0 percent; and 5) slashing employees' benefit such as housing allowances and education allowances for children, etc. There will be more to come, as these are similar paths taken by New York and London, and now Tokyo, to enhance government efficiency and reduce fiscal deficit.

The Education System: Reducing the Mismatch in the Labour Market

Majority of the lower skilled workforce lacks the skills and knowledge required by the new economy is one of the main reasons attributing to the widening social disparity and higher unemployment rates. To solve these problems, an education system that helps to enhance labour flexibility and skill levels is essential. Moreover, homegrown professionals and intellects, not the imported ones, provide long-term support to the development of a world city. Hence, our education system will play a central role in reducing the mismatch in the labour market.

In his third Policy Address, Chief Executive Tung Chee-Hwa emphasized on the concept of "life-long learning", outlining comprehensive reforms from kindergarten to tertiary education systems, and moved to improve the quality of school principals and ways to broaden access to education for people in all ages through community colleges. The Government's policies in this area have been generally well received by the public. However, the Government can do more in encouraging the public to continuously upgrade themselves by providing Government grants or tax incentives. The Government has done its part, but it is equally important for individuals to have the will to upgrade themselves. So, the education reform should be directed to nurture the culture of reading, study, and life-long learning.

Conclusion

When the SAR Government identifies its target to build Hong Kong as a first-tier world city, we should also prepare for the problems related with the developmental process. In the past, Hong Kong was able to escape from the economic pains stemmed from the migration of manufacturing industries because of the asset bubble and China's open door policy. However, it does not mean Hong Kong can escape the economic problems associated with moving up the value-added ladder, as it was experienced in London and New York during the 1980s.

The end of the property-based economy revealed that the related adjustment pains had merely been postponed. At the beginning of 2000, these problems will gradually surface, including structural unemployment, a widening wealth gap and a growing budget deficit. Many parts of Hong Kong's domestic economy need to be exposed to more deregulation and privatization, which would in turn bring about a more modern and efficient service-based economy. These are similar to the problems that New York and London tackled during 1980s and 1990s - a difficult process that culminated in these two cities flourishing as the first-tier "world cities" that Hong Kong seeks to emulate.

The Hong Kong Economy

Review

In 1999, the Hong Kong economy started to recover in the midst of unprecedented price deflation. Real GDP growth rebounded to 4.5 percent in the third quarter, while prices generally fell by 5.9 percent during the period. The main thrust of this growth was a rebound in exports of goods and services, which recorded 8.1 percent and 10.2 percent real increases respectively.

The domestic economy was more subdued. Private consumption grew by a moderate 3.0 percent in the third quarter. Price discounts successfully boosted retail volume but not profits. Consumer confidence was far from recovering, with unemployment at around 6 percent. Investment remained sluggish among the business community, with the stagnant property market and deflationary environment keeping investors hesitant. Investment fell by 19.8 percent in the first nine months of 1999. However, with the strong turnaround of the external sector, real GDP is projected to increase by about 2.0 percent in 1999.

Outlook

Looking ahead, positive external developments will continue to drive the Hong Kong economy forward. With major trading partners projected to have solid growth, Hong Kong's exports of goods and services are projected to rise by 9.9 percent and 6.5 percent respectively. Despite stronger external demand, domestic exports will grow at a significantly slower pace than re-exports, as China's accession to the WTO will accelerate the migration of manufacturing-related activities to the Mainland. Domestic exports are forecast to have 2.0 percent growth, while re-exports should grow by 11.0 percent. Meanwhile, the restocking of inventories will boost retained imports, which are projected to grow by 11.5 percent.

The domestic economy, on the other hand, is expected to lag behind. Improved performance in trade-related sectors will boost domestic employment opportunities and business receipts. Meanwhile, the foreign investment should continue to be attracted by China's imminent accession to the WTO. These, together with a busier schedule of public infrastructure development, will help to stimulate domestic consumption and investment. However, domestic consumption may continue to lag behind, owing to continuing high unemployment, corporate efficiency measures and prices stagnation. Private consumption and investment are projected to grow by moderate rates of 3.4 percent and 3.5 percent respectively. We will therefore continue to see resources flowing from domestic to external sectors. GDP for 2000 is projected to increase by 4.5 percent.

The viewpoints expressed in the Economic Analysis do not necessarily reflect those of Management of this Bank. Reprinting of any figures or statements contained herein is permitted provided that proper attribution is given to the Economic Analysis and/or the BEA Economic Research Department. Please direct any inquiries to Economic Research Department. Tel: 2842-3513, Fax: 2877-6707, or GPO Box 31, Hong Kong