As one of the freest economy in the world, Hong Kong's industry restructuring is widely believed to be driven by market forces. There are few people showing concerns and actively investigating on that issue. It is only after the Asian Financial Crisis in 1997 that industry restructuring became a more widely discussed topic in the territory. At that time, Hong Kong was hard hit by plunging property price, deep economic recession, sky-high unemployment rate and large fiscal deficit, etc. Since then, the society has begun to realize the structural nature of the problems in Hong Kong. Many believe that Hong Kong should diversify its economy through industry restructuring.

Accordingly, a number of proposals had been put forward on transforming Hong Kong's economy, including developing information technology, Chinese medicine, local community economy, dual economy and re-industrialization, etc. The Hong Kong SAR Government also formulated policies to foster the development of hi-tech manufacturing. In 1998, the Government established the Commission on Innovation and Technology chaired by Professor Tien Chang Lin. In the Second and Final report submitted in 1999, the Commission recommended developing Hong Kong into an innovation and technology centre for South China and the region, and to partner with PCCW to develop the Cyberport in Po Fu Lam. Other measures such as the immigration scheme for Mainland talents and professionals and Cepa "Zero tariff" are also part of the restructuring efforts pioneered by the Hong Kong SAR Government.

Over the past seven years, there have been some transformations taking place in Hong Kong. According to recent statistics, we can identify two main features, the first being that the proportion of secondary industry continued to fall from 14.7% in 1997 to 12.3% in 2002. During the same period, the proportion of manufacturing also fell from 6.4% to 4.5%. The second feature is the rapid growth of non-productive service sector, which can be reflected in the fast expansion of the community, social and personal services industry. Its compound annualized growth rate reached 5.3% between 1997 and 2002, the highest among all service sectors. Its ratio to GDP also rose from 17.4% to 22.2%, as indicated in the attached table. In summary, several key trends emerge: (a) Hong Kong's industry structure has not been successfully diversified, as it has become more service oriented. (b) The growth of the service sector mainly comes from the rapid expansion of the non-productive section, such as social welfare services. (c) The effect of CEPA in reviving the manufacturing sector is not remarkable. (d) Based on the company bankruptcy filings, the adjustment in property price, rent and wage have not helped the SMEs much. This is because business opportunities are also lost during the economic adjustment. However, there are several bright spots. The poor economic environment forced businesses to apply new technology and new business models, which could enhance their performance as well as quality. As a result, the proportion of all value-added activities in Hong Kong increased from 55.3% in 1997 to 56.4%, reflecting higher industrial efficiency.

All in all, Hong Kong's broad adjustments triggered by the Asia Financial Crisis have not resulted in industrial restructuring. The recent economic recovery is still led by those traditional engines such as finance, trade, property and tourism. The liberalization of travel restrictions of Mainland tourists helps boost the tourism sector while the rebound in property price helps boost the investment sentiment and consumer confidence that are keys to the economic recovery.

B. Rethinking the Issues in Hong Kong's Industry Restructuring

After reviewing the experience of the past seven years, there are at least two issues that require further investigation or analysis. The first one is why Hong Kong's manufacturing sector continues to contract even under strong supporting efforts. The other is whether the over reliance on the service sector is beneficial to Hong Kong's long-term economic health.

Regarding the first issue, I have four main explanations:

(i) In term of GDP per capita, Hong Kong's economy is now in the post-industrialization stage. The high cost structure has hindered the redevelopment of manufacturing. Many classic economic researches support this argument. American Economist Hollis B Chenery believed that we should use GDP per capita as a measure of industrial evolution. According to Chenery's model, Hong Kong with a per capita GDP of about US$25,000 no doubt has entered the post-industrialization stage. Additionally, Economist Walt W Rostow stated in his research titled "Stages of Economic Growth" that in a particular stage of development, there were unique structural characteristics and leading industries. The most advanced stage of economic development should be the stage of pursuing living quality. Its leading industries should include service and rural construction. Hong Kong's economy has indeed been in the stage of pursuing living quality. Furthermore, Professor Michael E. Porter based his research on the competitiveness of different countries. A particular economy should have three development stages, i.e. factor driven, investment driven and innovation driven ones. According to Porter's model, Hong Kong should be classified as an innovation driven economy. All of the above researches suggest that an economy's development has its regular pattern, evolving from agricultural, industrial to service oriented. After an economy has entered into the post-industrialization stage, its cost and manpower structure has already been very different from those in the industrialization stage, rendering it almost impossible to return to the former routes.

(ii) Hong Kong's local industries do not possess core technology, which is opposite to the usual experience by many well-developed economies. According to Chenery, he classified the industrialization processes into three different phases. Additionally, based on international experience, a complete industrialization process should involve an economy developing some unique core technology, and forming the cluster effects. In the advanced stage, even if production is relocated to lower cost bases, the core technology manufacturing will still remain in the origin countries. The experiences of Singapore, Taiwan, South Korea, Japan, US and Europe all can testify to such outcomes. However, Hong Kong has relocated most of its manufacturing activities to the PRD area at a time when it had not yet completed all three phases of industrialization. As a result, there is no core industrial technology or cluster formation left in Hong Kong. The manufacturing sector does not have strong footings in the area any more.

(iii) Hong Kong's special relationship with China allowed division of labor. The manufacturing sector has outsourced productions to the PRD while retaining the supporting activities in Hong Kong that include order processing, product design, financing, sales and marketing etc. Obviously, Hong Kong and the PRD have developed some form of division of labor in their value-chain, allowing the Hong Kong manufacturers to take full advantages of the differential cost structures.

(iv) The HKSAR Government has always abided by the principles of non-intervention and market economy. According to international experience, the governments of the Asian dragons have all provided strong supports for the development of manufacturing. In the early 1980s, Hong Kong's Government continued to uphold its free-market principle and adopt a lassie faire attitude towards retaining manufacturing, even though they started to relocate to the PRD area. In recent years, the Government still maintains its principle of "Market Leads, Government Facilitates". Therefore, it is mainly a market driven result that no high tech manufacturing is developed in Hong Kong.

The second is whether it is appropriate to have a strong focus on service

In Hong Kong, the service sector accounts for 87% of the economy, a ratio far higher than Singapore, Taiwan, Finland and Switzerland's by about 20 percentage points. Is this industry structure suitable for Hong Kong? There is no consensus. Some argue that Hong Kong is a city economy, just like New York and London that concentrate on financial services. In this case, there is no need to pursue a balanced industry structure. Hong Kong's growth can be sustained by expanding our hinterland further into the Mainland under CEPA.

I partially agree with this argument though, because the economic relationship between Hong Kong and China is far different from those of New York and London to the US and UK. Even though China has resumed its sovereignty over Hong Kong, Hong Kong still maintains its independent legal system, monetary system, and customs etc. In addition, a border still exists between Hong Kong and the Mainland. In economic perspectives, Hong Kong is an offshore economic and financial centre for China and the economic integration with the Mainland has not fundamentally altered its status as a small and independent economic entity. Therefore, Hong Kong not only has to enhance its financial, logistics and tourism industries, but also has to foster new growth engines in order to expand its industry and tax bases.

C. Outlook of Industrial Restructuring

Based on the above discussions, there are at least two implications:(i) Hong Kong possesses a comparative advantage in the financial sector instead of the manufacturing sector. In term of development trend, the proportion of the manufacturing in total GDP might continue to fall. This could mainly be due to the abolition of textile quota that might drive the remaining textiles industries to China. The textile industry produces more than $10 billion worth of output each year, accounting for one-fifth of our total manufacturing output;(ii) Industry diversification in Hong Kong does not necessarily mean that Hong Kong has to redevelop manufacturing because Hong Kong has already progressed well into an innovation-driven economy. To ensure sustainable growth, Hong Kong should develop more knowledge-based, innovation driven and service industries. The key to Hong Kong's industry restructuring should be the development of both higher value-added and productive based industries. It is not important whether those higher value-added and productive industries are classified as secondary or tertiary industries because in reality, the distinction has becomes far less important than in the past.

I believe that financial service, logistics, property, tourism and producer services are the five traditional pillars of Hong Kong's economy. In term of emerging industries, arts, film and music production, publishing, theme park, tutoring and training, healthcare and beauty, organic food production, business consulting are all knowledge-based and innovative services that have the potential to grow and prosper in the future. Indeed, fitness and beauty, tutoring and training together with organic food production all have witnessed rapid growth in recent years and become the new bright spots of our economy.

On the other hand, the environmental industry also possesses strong growth potential. The Policy Address this year proposes that the Government will support the development of the recycling industry in Hong Kong. Moreover, the Legislative Council also passed a bill to formulate a long-term recycling policy. This suggests that both the administrative and legislative arms have reached an understanding on the issue. The HKSAR Government is planning to build a Recovery Park in Tuen Mun. The Government will also consider granting some form of tax relief to support its development. In fact, Hong Kong also faces strong external pressure to develop its recycling industry. The European Union has passed an environmental regulation on electronic products that requires 65% of its components to be reusable. In Hong Kong, all the landfills are expected to be full in the coming six to ten years. Hong Kong also has to find ways to resolve its pollution problems. In fact, the recycling industry has huge economic benefits. The output of the recycling industry in Singapore, Taiwan and South Korea amount to $10 billion, $30 billion and $50 billion respectively while Hong Kong's only reaches $1 billion. Furthermore, the recycling ratio is only 40% in Hong Kong, far lower than the 75% in most developed countries. This suggests that Hong Kong has much room in expanding and developing its recycling industry.

Hong Kong is also carrying out or will carry out a number of strategic infrastructure constructions in the coming years that include the Disneyland, the Hong Kong-Zhuhai-Macau bridge, new tourism attraction points in the Lantau Island, cultural projects on both sides of the Victoria Harbour, cruise terminal, Ocean Park redevelopment scheme etc. Combined with the recent proposal to abolish the estate duty, they will benefit the developments of the financial service, cultural and other emerging industries.

To conclude, although it is the traditional sectors that have spearheaded Hong Kong's economic recovery, it does not necessarily mean that the discussions and explorations on Hong Kong's industry restructuring in the past few years are pointless. Instead, it provides a foundation for us to better understand what our advantages are and which direction future industry restructuring will go. As our service oriented economy will continue to be affected by external environments and market volatilities, Soloing as we can equip ourselves with better risk awareness and adaptability, such volatilities can be minimized.

Tse Kwok Leung
Senior Economist
 

Development Trend of Hong Kong's Service Industries (% of GDP)

Source: (Gross Domestic Products) 2003

Economic Activities (% of GDP)

Remark: Based on current market price
*Less than 0.1%
Source: (Gross Domestic Products) 2003

Development Trend of Hong Kong's Industry Structure