1. Characteristics and Performance

One of the major characteristics of Hong Kong's trade transformation is that the ratio of domestic exports to total trade declined steadily. From its peak of 81% in the early 1970's, the ratio continued its downturn in the early 1980's when the manufacturing industry moved away from Hong Kong, to 35.3% by early 1990's and eventually to only 8.7% during the first nine months in 2002. The ratio of re-exports to total trade, on the other hand, increased drastically. These dramatic changes revealed the following: (1) Domestic exports declined in terms of both absolute volume and in relation to total exports. Total value of domestic exports last year was roughly the same as that of 1982, down 34.4% from its peak in 1992. A sharp decline in the manufacturing sector contributed to the high unemployment rates in recent years; (2) Trade transformation in Hong Kong was not just a simple structural adjustment, but rather a process closely connected to increase in total exports as well as recovery and development of Hong Kong as a re-export center. The ratio of total re-exports to GDP rose drastically from 15.5% in 1978 to 105.1% last year, contributing steadily to the economy; (3) Hong Kong's increase in re-export functions was mainly a result of the relocation of Hong Kong's manufacturing operation and expansion of the territory's processing trade activities. More than 80% of the goods re-exported in Hong Kong last year were Mainland-related, out of which 70% were processing trade. Without the relocation and expansion of processing trade activities, the recovery and development of Hong Kong's role as a re-export center could not have been achieved. On the other hand, the slowdown of Hong Kong's re-exports in recent years was also closely related to processing trade development in the Mainland, especially the Pearl River Delta.

Another characteristic is the transformation from re-exporting to offshore trading. As the growth of re-exports slowed down, offshore trade developed dramatically. Offshore trade is a type of international trade in which part of its operation and administration are conducted in Hong Kong, but the goods do not actually pass through the SAR. The major distinction between offshore trade and re-export is that for the former, the goods go directly from the suppliers to the destination without going through the customs office of Hong Kong. The SAR government has long excluded offshore trades from the statistics of foreign trade, and counted them as value-added services in "service exports related to international trade" (SERIT). Only recently did the government provide official statistics for offshore trade for the fiscal years 1999 and 2000. From the limited data available, we note that more than 80% of SERIT was offshore trade. From 1996 to 2000, the average annual growth rate of re-exports was only 3.8% versus the annual growth of SERIT at 11.4%. The ratio of the value added from SERIT to that of traditional trade increased from less than 30% to 44.1%. In addition, according to the statistics from Hong Kong Trade Development Council (see the table below), the total value of offshore trades in 1997 was HK$ 1 trillion, comprising 84.5% of the total value of re-exports. In 2000, the value of offshore trade amounted to HK$ 1.4 trillion, exceeding that of re-exports for the first time. Between 1997 and 2000, offshore trade grew at 10.6% per annum, well above re-export growth rate. On the one hand, the rapid growth in offshore trade was partly a result of the increasing growth of the manufacture sector and foreign trades in the ex-Guangdong area, especially in the Yangtze River Delta. (In the past three years, the annual growth of total imports and exports in Guangdong Province was 10.8%, while that of the Mainland China excluding Guangdong and that of the Yangtze River Delta was 19.7% and 26%, respectively.) On the other hand, the growth in offshore trade was also partly caused by the rapid growth in trade supporting services in the Mainland, especially the Pearl River Delta. According to some related surveys, most of the trades were conducted offshore in order to reduce transportation costs and to meet customers' preference for direct shipping from the Mainland. However, most of the offshore trades are related to low value-added products, while the high value-added products such as jewelries and watches are still largely traded in Hong Kong.

HKTDC Figures on Offshore Trade (HK$ billion)

The third characteristic is the transformation from processing trade to non-processing trade. The ratio of processing trades increased steadily and that of non- processing trades trade decreased. According to the government's statistics, Hong Kong's total trade volume with the Mainland grew at an annual rate of 7.8% from 1999 to 2001, among which the growth of trades related to processing trades was only 4.6% while that of non-processing trades was a striking 14.3%. The ratio of processing trades declined from 68.4% to 64.5%, with an annual growth of roughly -2%. In the first half of 2002, the growth of bilateral trade between Hong Kong and the Mainland was only 2.3%. Processing trades declined by 7.8% while non-processing trade increased sharply by 21.2%. The increasing share of non-processing trade was due to the fact that more re-export products made by Mainland's enterprises were traded through Hong Kong and more multi-national corporations established their production and procurement centers in the Mainland and exported their products through Hong Kong. Also, Hong Kong's direct investments in the Mainland now concentrate on the infrastructure and service sectors, resulting in the slowdown of processing trade and increase in offshore trade. Because processing trade has contributed significantly to the development of Hong Kong as a re-export center for the past 20 years, its recent slowdown was the major reason hindering Hong Kong's foreign trade performance. Theoretically speaking, only non-processing trade can reflect Hong Kong's status and function as an intermediary for foreign trade. Non-processing trade growth between Hong Kong and the Mainland was roughly the same as total international import/export growth in the Mainland, implying that Hong Kong's role as a trade intermediary is not worsening so rapidly as commonly perceived. The most important factor accounting for the slowdown in Hong Kong's foreign trade growth, therefore, is in processing trade, a major driving force for Hong Kong's economic boom in the past.

2. Effects and Implications

Trade transformation has positive expanding effects as well as negative ones. On the positive side, trade transformation resulted in more diversified forms of trading. Domestic product exports, offshore trade, processing and non-processing trades formed a complete set of trading services. This comprehensive trading development, coupled with increase in offshore trade, had broadened the Hong Kong market to meet the specific needs of different customers, thereby enhancing the trading functions and capacity of Hong Kong. Secondly, the development of Hong Kong's re-exports led by processing trade in the past 20 years boosted Hong Kong's ranking in terms of total foreign trade volume from the world's No. 21 in 1980 to No. 8 in 1997. However, Hong Kong's ranking has dropped in recent years mainly because offshore trade was excluded from the total trade volume. Had the total offshore trade volume been considered, Hong Kong's ranking could have been much higher. Thirdly, trade transformation is the major propelling force for Hong Kong's economic development. Over the past 20 years, Hong Kong developed its leading role in global import/export trade through re-exports. The ratio of value-added import/exports to GDP rose from about 10% in the early 1980's to 18% in 2000. The development of offshore trade in recent years was largely reflected in the rapid growth of SERIT services in Hong Kong. According to the Government's statistics, SERIT services made up about 5% of GDP from 1980 to 1995, but had increased to 8.4% in 2000, reflecting the speedy rise in offshore trade. If we count in the value added from import/exports during the same period, the total international trade and trade-related services in Hong Kong would represent 26.3% of GDP in 2000, compared with only 14.6% in 1980. In other words, trade transformation has not eroded Hong Kong's foreign trade-led economic development, but rather it has reinforced Hong Kong's status incessantly. During 1980 to 1995, led by re-exports, import/exports had contributed to increase in GDP growth rate of at least 1.2%, or an average of 20% growth on total GDP for the same period. From 1996 to 2000, the value added from SERIT comprised of 24% GDP growth, while the comparable figures for import/exports and the finance industry were 22% and 21%, respectively. Therefore, SERIT services have become the most important source of Hong Kong's economy development.

Total Foreign Trade Volume as a Percentage of GDP (%)

From the above we can see the tremendous expansionary effects that trade transformation can have on Hong Kong's economy. Offshore trade and re-exports are vital to Hong Kong's growth, without which Hong Kong would not have been able to shed its light as an international trading center amid the chilly economic situation, or it could have been worse during the past few years.

On the other hand, we should also recognize the mixed effects resulting from trade transformation. Firstly, Hong Kong's traditional trade center role has been undermined consistently. In the early 1990's, the ratio of bilateral trade between Hong Kong and the Mainland to China's total foreign trade volume reached its peak of 50% and declined gradually after that. The ratio dropped further from 44% in 1997 to 31% last year, and only 28% from January to August this year. More and more Mainland-made products were shipped directly to the destinations without passing through Hong Kong. Secondly, different forms of trade would affect Hong Kong's economy to different extents. (In 2000, the value-added ratio of domestic exports, re-exports, and offshore trades were 40%, 21.1%, and 8.6%, respectively.) The shift from high value-added trade to lower value-added ones would certainly have negative effects on the territory's economy performance. For example, from 1997 to 2000, offshore trade in Hong Kong increased by roughly HK$ 400 billion. If all the goods were re-exported through Hong Kong, the territory's annual GDP growth could have gone up by 1%. In other words, if more and more Mainland-made products bypassed Hong Kong ports, the economic growth of the SAR would be adversely affected. At the same time, the implications on the local economy from different forms of trade are also different. The local manufacturing, import/exports trade, and trade supporting services sectors can all benefit from domestic exports, which is the major driving force on consumption, investment and the local economy as a whole. Re-exports trade has less significant effects on the local economy as it can only promote the import/exports and trade-supporting sectors. Offshore trade can affect trade-related services only and its effects are also small. Thirdly, trade transformation also poses different implications on various trade-related service sectors. According to the Hong Kong Trade Development Council's survey, the location arrangement varies from industry to industry for both direct shipments and re-exports of the China-made products. For example, only less than 20% of China-made products are shipped from Hong Kong, while the ratios are 60% to 80% for other services such as testing/assurance, arbitrary service, and trade-related insurance. The least affected service is trade financing because more than 80% of it is conducted in Hong Kong. Lastly, trade transformation has enormous effects on the territory's job market. With the hollowing of Hong Kong's manufacturing industry, the number of total employment in the sector dropped from its peak of over one million to less than 300,000 today. The figure would still be less than its peak number even if we include in it total employment in trade-supporting services sector. From 1997 to 2000, offshore trade increased by HK$ 400 billion. If all these trades had been conducted as re-exports, it could have increased the number of employment opportunities in Hong Kong by 30,000 in the transportation industry alone.

Of course, discussions on the implications of trade transformation do not necessarily mean these trades must be conducted through Hong Kong one way or the other. For example, if offshore shipment were not used, re-export through Hong Kong is not the only way out. By the same token, neither is offshore trading an automatic replacement of re-exports for Hong Kong. While assessments on the effects of trade transformation should take into account the specific circumstances, nevertheless, we can still identify the basic changes and developments in Hong Kong's international trade sector. And trade transformation will continue to play a significant role on Hong Kong's foreign trade in the future.

3. Trends and Prospects

The following factors are vital to Hong Kong's trade transformation: (1). The development of trade-supporting services in the Pearl River Delta. As the Pearl River Delta continues to develop, its reliance on Hong Kong will drop in relative terms in the future. Hong Kong's trade transformation will be further expedited as the major type of trade transfer from re-exports to offshore trades. Take container shipping as an example, 90% of the containers were shipped through Hong Kong in the middle of 1990's, while the figure was only 70% last year. It is estimated that the ratio will drop further to only 50% by 2010; (2) The effects of China's entry into the WTO and the opening of its markets. After China's entry into the WTO, the imports and exports of the Mainland will grow at an annual rate of 10% in the next 10 years. By 2010, total imports and exports will increase to $ 1200 billion from today's $ 600 billion. Hong Kong will also benefit from the expansion of the trade volume of the Mainland. At the same time, more foreign-owned enterprises will develop its distribution channels and will procure directly in the Mainland. Hong Kong's trading firms will also increase their direct exports from the Mainland, which in turn will accelerate the development of offshore trading and Hong Kong's trade transformation; (3) Hong Kong's policies in developing the logistics industry. The Hong Kong SAR government considered the development logistics industry as a vital part of Hong Kong's economy in its 2000 policy address, and set up a designated group to promote the industry. In its 2002 Budget Report, the government put it as one of the four pillar industries. The government opened the fifth-freedom traffic rights recently. All these will provide a favorable environment for its growth. However, compared with the major competitors, Hong Kong's logistics industry is still lagging behind. With high costs, less experience, lack of preferential policies and expertise, Hong Kong is now facing fierce competitions from the neighboring countries. For example, Singapore began its development of logistics industry 10 years earlier than Hong Kong and it is now an important logistics center in the Asia-Pacific region. The Pearl River Delta also has ambitious and forward-looking logistics development plans. Logistics industry is considered as one of the most important industries in Guangzhou, Shenzhen, and Zhuhai. The rise of the logistics industry in the Pearl River Delta brings new opportunities for co-operation as well as more severe competitions.

From the above-mentioned factors we can get some insights on the trends of trade transformation. (1) Trade transformation will be expedited further. Domestic product exports will decrease in both absolute and relative terms. Re-exports will maintain a low annual growth rate of about 5%, while offshore trades may increase by 10% annually; (2) Offshore trade will be the major driving force for trade development in Hong Kong. In 2000, the volume of offshore trade had already exceeded that of re-exports. The value added from offshore trade comprised approximately 40% of those from re-exports. It is anticipated to increase to around 70% in 2010 and exceed re-exports by 2020 to become a major international trade of Hong Kong; (3) The importance of processing trades will shrink gradually and non-processing trade will continue to be the major propelling force of Hong Kong's imports and exports. It is estimated that by 2010, the ratio of processing trade to Hong Kong's total trade will decline to less than 50% from last year's 64.5%. Non-processing trade, on the other hand, will become one of the major traditional trades. Generally speaking, the importance of traditional trades will decrease gradually and offshore trade will play a crucial role in the future. Hong Kong will transfer from a re-export center to a diversified trading center for the operations and administration of international trades.

The prospects of Hong Kong's trade transformation will ultimately depend on the development of Hong Kong's modern logistics industry. Developing a competitive logistics industry will not only promote the transformation of Hong Kong's economy and create more job opportunities, but also strengthen Hong Kong's role in the international arena of industrial specialization and in China's economic development. Hong Kong is now experiencing a difficult restructuring process. The SAR should embrace changes in the economy, globalization, and China's entry into the WTO and strengthen its logistics infrastructure and lower the costs in the logistics sector. Also, preferential policies should be adopted to encourage logistics investments from multinational corporations. In addition, Hong Kong should also reinforce its cooperation with the Mainland, especially the Pearl River Delta, to develop itself into the most important logistics center in Asia-Pacific Area. Hong Kong should also pay special attention on the rise of offshore trade and step up efforts to formulate appropriate policies and measures. As long as the logistics industry can achieve greater development, Hong Kong's trade transformation will have a better prospect.

Wong Chun Xin