• While Hong Kong's role as an entrepôt for handling trade in physical goods will diminish over time, it will continue to excel as an important hub for managing invisible offshore trade and trading of capital and financial market instruments.

The latest trade and port cargo statistics indicate that Hong Kong's trade growth lags substantially behind that of mainland China. This has raised questions of how - and for how long - Hong Kong will continue to benefit from the Mainland's booming export trade. Hong Kong's status as a primary entrepôt for Mainland products is now under challenge. Hong Kong should not ignore the fact that it may no longer have comparative advantages in handling physical exports from the Mainland on their way to other destinations. By accepting this reality, the territory can shift its energies to focus on areas in which it can still excel - namely, becoming a hub for the trade of "invisible" goods and services, such as offshore trade that is not reflected in the statistics, and capital and financial market instruments.

Trade in Perspective

International trade has long been a defining characteristic of the Hong Kong economy, but its nature has undergone major changes over time. Beginning in the 1950s, exports of domestically produced light industrial products served as the engine of growth for nearly three decades. Since 1979, investment has increasingly flowed into the Mainland, resulting in the gradual relocation of manufacturing facilities to neighbouring Guangdong Province and growing volumes of Mainland-manufactured goods shipped overseas via Hong Kong. Shipment and transhipment of these cargos have turned Hong Kong into a key trading and logistics centre.

The value of Hong Kong's re-exports has increased dramatically since 1985, replacing domestic exports as the key driver of growth. Re-exports now account for about 95% of Hong Kong's total exports. Mainland-related trade flows, with the Mainland either as the destination or as the origin of shipment, totalled about 110% of the HKD2,327 billion in re-exports trade recorded in Hong Kong in 2006. Moreover, services exports, the majority of which are related to trade and the transportation of goods, exceeded the value of domestic exports a decade ago.

However, increasing evidence suggests that Hong Kong's role as an entrepôt for products entering and leaving the Mainland is under challenge. While Mainland exports expanded by an average of over 38% per annum between 2001 and 2006, Hong Kong's re-exports growth was only 15% per annum during the same period (Chart 1). Hong Kong's re-exports as a percentage of the Mainland's total exports peaked at 120% in 1993 and has gradually declined to only 30% in 2006. Hong Kong's re-exports and the Mainland's exports are still highly correlated, but the relationship has been weakening.

In the first quarter of 2007, while the Mainland's exports expanded by 28% year-on-year, Hong Kong's re-export growth was only 12%. At Hong Kong's container ports, there has also been a sharp slowdown of throughput growth - from 8% in 2002 to only 2% in Q1 2007. In contrast, container throughput at ports in Shenzhen and Shanghai expanded at an average annual rate of 25% and 26% respectively between 2002 and 2006. It appears that an increasing volume of Mainland-manufactured products are exported through domestic container ports. In the first quarter of this year, container throughput at Shanghai's fast-growing port exceeded that of Hong Kong.

The Role of Trade in the Hong Kong Economy

Despite some signs that the link between Hong Kong's re-exports and Mainland trade is weakening, re-export trade is still of vital importance to Hong Kong. The total value of "visible" trade handled by the territory was 3.4 times the value of its GDP in 2006, compared with only 1.5 times in 1980. Trading and logistics overtook the manufacturing sector to become the largest contributor to Hong Kong's GDP in 1988. More importantly, trade is the engine of Hong Kong's economy. The trade and logistics sector's share of GDP has doubled from about 15% in 1980 to 29% in 2005. The trade-related sector also provides more jobs than any other business sector. In 2005, it employed 835,500 people, equivalent to 24.7% of Hong Kong's total workforce.

Sluggish growth in container port cargo volumes due to rising competition from Shenzhen and Shanghai have been made up for in part by a rising volume of air cargo. Hong Kong's traded goods are increasingly reliant on air transportation for handling. Trade by air in terms of value expanded by an annual average of 11.8% between 1995 and 2006. In 2006, 35% of Hong Kong's total exports by value were transported by air, up from 20% in 1995.

This shift is largely due to a changing product mix, with a sharp rise in electronics products, which accounted for about 50% of Hong Kong's total exports in 2006. Most electronics products have relatively short product lifecycles, with buyers tending to keep inventory levels low and demanding short delivery lead times. Hong Kong is undisputedly a leading air cargo hub for the region, well connected to more than 140 destinations worldwide by nearly 80 airlines that provide about 5,300 scheduled passenger and all-cargo flights each week. Its efficiency in air cargo handling makes the city an ideal place to serve regional trade flows.

On top of trade in "visible" goods, Hong Kong also derives benefits from handling a massive volume of "invisible" offshore trade. In general terms, Hong Kong's importers/exporters conduct trade in the following ways: (1) domestic export; (2) re-export through Hong Kong; (3) transhipment via Hong Kong with through-bill-of-lading; and (4) direct shipment from place of origin. Transhipment and direct shipment are referred as "offshore trade" under which merchandise trade is handled by an office located in Hong Kong, but the goods themselves do not physically enter or leave Hong Kong (Chart 2). Without any customs clearing, this type of trade is less "visible" as it is not included in Hong Kong's external trade statistics. It is viewed as "services rendered" and related earnings are treated as income from exports of services.

The increasing importance of offshore trade is a result of the expansion of manufacturing capacity beyond the Pearl River Delta. Since the opening up of Shanghai and the surrounding region in the mid-1980s, the Yangtze River Delta has developed into a sizable manufacturing base. More production is taking place in the Yangtze River Delta region, and it is difficult for Hong Kong's ports to capture business opportunities beyond southern China.

Detailed statistics on offshore trade have only been available since 2002. Further, these are often subject to time lags given the time required to collect the relevant data. Hong Kong's offshore trade expanded at an annual average rate of 12.7% between 2002 and 2005 in terms of value. According to Census and Statistics Department, the value of offshore trade in the territory was HKD2,087 billion in 2005, comparable to that of re-exports at HKD2,114 billion (Chart 3). Thus, re-export statistics have limitations regarding the provision of the whole picture of Hong Kong's external merchandise trade.

The Challenge: Beyond Entrepôt

Despite the challenges, it is fair to assume that Hong Kong's re-export trade will maintain reasonable momentum and continue to underpin economic growth in the short term, particularly given the stellar export performance of the Mainland. However, offshore trade will likely play an increasingly significant role over the longer term. Therefore, it should not be a surprise - and need not be devastating - if the handling of physical goods passing through Hong Kong's ports ceases to be the key driver of the economy in the future.

The growth potential of offshore trade is huge, as it is not limited by geographical boundaries. The volume of offshore traded goods that can be handled by Hong Kong is not constrained by Hong Kong's port or airport capacity, but only by the availability of profitable trade opportunities and the ability to provide value-added services. The economy will also benefit from the increasing demand for related ancillary services, such as marketing, legal and accounting. The remaining challenge in moving from re-exports to offshore trade in the longer term will be the effects of changes in the trade sector on the rest of the economy as offshore trade utilises less of Hong Kong's physical facilities, commands a smaller gross margin and provides fewer job openings for less-skilled labour.

That said, Hong Kong appears on track as regards adapting to its new role. It is the most important "financial entrepôt" in the region, providing a financial platform for banks and other financial institutions in the territory to transact all kinds of financial business, whether denominated in local or foreign currencies or originating onshore or offshore. Its financial platform is unmatched for trading Mainland-related financial instruments and handling Mainland-related international fund flows.

The Hong Kong entrepôt concept can be further extended by the fact that Hong Kong is the preferred regional management centre for business, people and funds for many companies and decision makers. Hong Kong is home to the regional headquarters of around 4,000 overseas companies. All these factors demonstrate Hong Kong's important middleman role in helping the Mainland to further integrate into the global economy, which has in turn transformed the territory into a key metropolis of China and an international business hub.

Conclusion

The role of Hong Kong as an entrepôt for Mainland products will continue to evolve. Its function as a centre handling the movement of physical goods will further diminish over time. But the Hong Kong miracle will continue beyond this entrepôt concept. The growth of Hong Kong's service economy will be increasingly driven by its role as a "trading hub" for capital and financial market instruments for both domestic and Mainland enterprises.

MAJOR ECONOMIC INDICATORS