Before the handover, the surging property market masked the need for industrial diversification, which gained attention after the Asian Financial Crisis. The tech stock bubble in 2000 also prompted attempts to develop the tech sector. However, as our economy recovered strongly in the last two years, the society seems to lose focus again. The structural nature of economic development model often seems to be confused with issues of economic cycles.

The Current Industrial Composition

There is no secret that Hong Kong economy has morphed into a heavily service oriented one. According to government statistics based on current prices, our service sector accounted for 68.3%, 75.4% and 89.3% of the economy in 1980, 1990 and 2003 respectively, showing a continuously rising trend. It is estimated that its proportion in 2004 could top 90.0%. Meanwhile, other sectors including agriculture and fishing, mining and quarrying, manufacturing, electricity, gas and water and construction have been on the declining trend. The contraction of manufacturing sector has been the most severe, decreasing from 22.8% in 1980 to 16.7% and 3.7% in 1990 and 2003 respectively. With the textile and garment industries relocated to the Mainland at a faster pace after the expiration of the quota system, the manufacturing sector is forecasted to diminish further into an insignificant portion this year.

There are two characteristics of this trend that are worth mentioning. From 1980 to 2003, the manufacturing sector has contracted by a total of 19.1 percentage points to only 3.7% of the overall economy. Meanwhile, the service sector has gained 21.0 percentage points to 89.3%. This should be interpreted as evidence of vibrancy of the service sector that more than makes up for the demise of the manufacturing sector instead of at the expense of the latter. Moreover, the change in prices also plays a part. Using current prices, the service sector's proportion was 89.3% in 2003, greater than the 85.5% measured in constant prices. This suggests that the service sector commands greater pricing power and had positive price change in 2003 even the economy still suffered from deflation.

In the service sector breakdown, ownership of premises is one of the independent category which is considered as an economic activity. Between 1980, 1990 and 2003, it registered a rising proportion of 8.4%, 9.7% and 11.2% of the overall economy. Although it has yet recovered to the record 12.1% in 1999, it still is considered a significant part of our economy because of the double-digit weight. Combined with the construction and real estate sectors, the property related industries' proportion was 27.6%, 23.8% and 18.9% in 1980, 1990 and 2003 respectively. Although it is declining and far from the highs of 28.3% and 26.8% reached in 1981 and 1997, it is still considered as an important part of our economy and one of the primary sources of wealth effects. To avoid triggering property bubbles, the Government has refrained from openly calling for its development. And it is not included in the four core pillars of our economy, namely finance, logistics, tourism and commercial services. But because of its close tie to people's livelihood and significant proportion of our economy, its stable development takes on important meanings.

The Growth Consideration

The proposal of industrial diversification seemingly stems from concerns about our heavy concentration on the service sector. In the case of Hong Kong, it should mainly refer to the revitalization of the manufacturing sector. Of course, the proper approach is by expediting its development rather than deliberately slowing down the service sector development. But because of the free market doctrine that Hong Kong is observing, industrial diversification implies certain interventions in the free market, which places the bar high for its rationales.

To reach conclusions by simply comparing Hong Kong's industrial composition to other advanced economies could be misleading because we lack a comprehensive economic structure and hinterland. Instead, we are an independent, small, and open city economy. Therefore, Singapore should serve as a good reference because of its similarity to us. Based on current prices, the services and goods producing sectors, 80% of the latter being manufacturing industry, account for 61.7% and 33.1% of Singapore economy, mirroring Hong Kong industrial composition some twenty years ago. The question is: should we backtrack and redevelop manufacturing sector in order to attain industrial diversification?

The argument for this is that a proper industrial composition could yield more balanced growth and lower growth volatilities. To examine this argument, comparisons of economic growths of the two economies should produce valuable information as we both have achieved success through vastly different economic models.

Historically, Singapore has registered higher economic growth than Hong Kong. For example, its real GDP grew by 376%, 134% and 29% in the past 24 (from 1980 to 2004), 14 (from 1990 to 2004) and 8 years (since the turnover) respectively, markedly greater than Hong Kong's 241%, 78%, and 24% of growth in the same period. Its average annual growth is also higher, of course, seemingly supports the argument that Singapore possesses better growth model.

But the conclusion is just the opposite if you compare the per capita GDP. Converting into US dollars, the per capita GDP of Singapore only exceeded Hong Kong in the first few years in the 1980s, then in 1995, 1996 and 2004. In other years, Hong Kong outperformed, with the spread hit USD$4,406 in 1998. As the per capita GDP is calculated using current prices, the long lasting deflation that Hong Kong has experienced makes a significant difference. Singapore took only one year to emerge from deflation while Hong Kong has struggled with it for almost six years since the Asian Financial Crisis. Hong Kong's GDP deflator has declined 23.5% cumulatively from 1997 to 2004. In this regard, Hong Kong's performance in per capita GDP category is even more respectable, suggesting that concentrating on providing services can create significantly more wealth than the more balanced Singapore model.

The results from comparing volatilities to growth rates also support the notion that Hong Kong fares at least as well as Singapore. Here we use the simplest method to measure volatilities to economic growth rate by calculating its standard deviation over a certain period. During the past 24, 14 and 8 years, the standard deviation to Singapore's annual real GDP growth is 4.1%, 4.2% and 4.5% respectively, while that of Hong Kong's is 4.1%, 3.6%, and 4.8%. With close to thirty percentage points difference in the proportion of the manufacturing sector, the two economies register largely identical historical volatilities to their economic growth. This suggests that the two models have their pros and cons, and volatilities are determined primarily by the nature of being small and open city economies. There is no clear evidence to pick either model over the other in terms of economic growth.

The Employment Consideration

Industrial diversification is believed to be able to improve employment, which could serve the great need of Hong Kong. We are facing structural unemployment in the lower educated and skilled labor force spectrum under the shocks of technological progress. No matter how fast the economy grows, their unemployment rate would be hard to bring down. Reintroducing labour intensive industries are thought to be able to counter such a problem.

Relatively speaking, Singapore has done better by keeping its unemployment rate consistently lower. In 2004, its unemployment rate was 4.6%, 2.4 percentage points lower than Hong Kong. Only during 1985 to 1994 when Hong Kong economy took off had it done better. This demonstrates that in the economic down cycles, the labour market of a more balanced economy proves to be more resilient. Yet this still fails to account for the possibly huge difference caused by the deflation in Hong Kong, which could be further traced back to the fixed exchange rate mechanism. Nevertheless, industrial diversification seems to be undoubtedly positive on employment.

But the question remains at what price Hong Kong has to pay to pursue such a policy. Hong Kong used to have labour-intensive manufacturing industries, such as textile, garment and electronic watch making, etc. However, we also missed the opportunity to develop high tech and electronics industries, which happens to be a strong field for Singapore. The average nominal monthly earnings for its manufacturing employees reach SGD$3,126 or approximately HKD$14,000, higher than the average monthly wage of HKD$9,885 in Hong Kong. Although there are possible discrepancies in data collection, the gap might be smaller, the implication is that Hong Kong could gain at three fronts by mimicking Singapore's growth model, namely diversifying industrial structure, increasing income and reducing unemployment rate. Though Singapore workers earned higher wages, its land is less expensive than Hong Kong's and its tax regime is just as competitive. In view of these, the foundations for both economies to develop manufacturing industries are thought to be roughly equal. Therefore, the difference mainly lies in the role of the government, the education and skill level of its general labour force, which also prove to be the bottleneck for Hong Kong to overcome.

Thus, if Hong Kong aims to improve the employment of its lower educated and skilled labour force by revitalizing the labour intensive manufacturing industries and pursuing industrial diversification, it will violate the natural conditions of high costs and lower the chances for success. On the other hand, high value added manufacturing is capital and technology intensive in nature, which is unable to provide large scale unemployment relief. In the case of Singapore, its manufacturing clusters include biomedical manufacturing, transport engineering, precision engineering, chemicals, electronics and general manufacturing, with only the last category being labour intensive. To counter high cost deterrents set by the market force, the government has to subsidize heavily. The subsidy has to last and might still not make economic sense.

Take Hong Kong Disneyland as an example, the Government's investment is well over HKD$20bn, creating 18,000 jobs directly and indirectly in the advantageous tourism sector. Suppose the Government uses land and tax relief to create the same number of jobs in the labour intensive manufacturing, it can reduce the unemployment rate further by 0.5 percentage points. As an alternative, if the Government chooses to distribute the HKD$8.7bn inherent in the Disneyland's investment to the 18,000 people instead of actually proceeding with the manufacturing plan, each one will receive more than HKD$480,000 or close to ten years of social security payment using the highest monthly individual standard rates of HKD$4,150. This example serves as a good reminder of the lack of economic efficiency of such a plan. To conclude, redeveloping manufacturing sector by subsidizing heavily could only pass the test of employment. Other than that, it fails in both competitiveness and economic efficiency, thus presenting a less convincing argument.

The Government's Role

Strictly speaking, Hong Kong does possess labour-intensive manufacturing. It is just that it has largely relocated to the Mainland, employing tens of millions workers. Bringing them back might not yield desirable results, which can be seen in CEPA's implementations. As for the chances of success in developing high value added manufacturing, it should be decent providing that the Government gets actively involved, like the case of Singapore. It should not aim primarily at employment relief as well. Under the high cost structure, the employment issue has to be addressed fundamentally by population and education policies instead of industrial policies.

The fact that high value added manufacturing has not taken hold in Hong Kong even though public opinion is firmly supportive. suggests that market force alone might not be enough. The Government has to get involved proactively and intervene in the market. This is exactly how Singapore has succeeded. Its Government has taken measures, such as formulating comprehensive economic plan, passing rules and regulations, enacting preference and industrial policies, and investing directly or indirectly in the economy. These endeavors not only bore fruits in its economic restructuring and the second industrial revolution in the early 1980s, but also give birth to its electronics, IT, and biotechnology industries, etc. But in the case of Hong Kong, many obstacles have to be overcome before we can successfully adopt such an approach.

Hong Kong's economic doctrine is significantly different from that of Singapore. It used to emphasize active non-intervention, then market leads, government facilitates. To promote industrial diversification, the Government has to actively involve in the economy and change the current thinking, which will face high bars given the proven success of the current development model. Besides, the Government needs to reach consensus internally and the support from the society is also very important in order to avoid controversies, as industrial policies often imply policy favours and preferences granted to certain industries. The argument for it is that Hong Kong has no other choice when the governments in the region all gear up to support economic developments. The argument against it is not without rationale either. These include the concerns about the potential conflicts of commercial interests, operating efficiencies and deviation from fair competition. The Government, which has been ruled under the mandate of small government, also lacks the capability and experience of intervention. Therefore, eagerness for quick success and instant benefit could prove to be counterproductive.

The success of industrial policies also requires more time to play out and the cooperation of the economic and technological cycles. This is especially the case when Hong Kong does not have the consensus in developing what kind of high value added manufacturing industry. There is no doubt that private enterprises will bring various projects to the Government for support, but this practice is different from the Government dictated industrial policies. In the past ten years or so, besides major public utilities projects, the Government has gotten actively involved in the developments of Cyberport, Disneyland and West Kowloon Cultural District. The former was an attempt on high tech development, the latter two mainly on service industries. Thus, we could say that industrial diversification is almost a brand new attempt by the Hong Kong Government.

As a supporting mechanism, policy research is critical. But the Hong Kong Government does not possess strong resources after decades of free market and small government practices. Thus, the academic and research communities in Hong Kong need to shoulder some of the research burden and advise the Government. Related studies must shift from purely theoretical to practical, producing more comprehensive assessment and analysis to concrete proposals. Only by doing so, we can get results in the shortest time under limited resources. Otherwise, pinning all hopes on the stretched Government will compromise the efficiencies and results.