Henry C K Liu

Part 1: From colonialism to confusion

Part 2: Missing the boat to renewal

The article appeared in AToL on May 22, 2003

By the late 1970s, British Hong Kong's colonial officials and business leaders realized they could no longer put off the question of what would happen to the New Territories, which makes up more than 90 percent of Hong Kong's land area. The New Territories had been leased to Britain in 1898, for 99 years, so that lease was set to expire on July 1, 1997.

In 1979, the British government initiated talks with China about Hong Kong's future. Governor Murray MacLehose unexpectedly brought up the subject during a private meeting in Beijing with Chinese leader Deng Xiaoping, who made it clear that China intended to reclaim Hong Kong.

In 1982, on the heels of victory in the Falkland Islands, British prime minister Margaret Thatcher made an ill-fated attempt to perpetuate British colonial rule over Hong Kong. She proposed British administration of Hong Kong after 1997, which Chinese officials rejected outright. Thatcher not only insisted on British sovereignty in Hong Kong, but also insisted that the unequal New Territories Treaty signed in 1898 was legal. China is not Argentina, and Deng stated his clear intent to take back Hong Kong in 1997. The bilateral talks over Hong Kong quickly deadlocked. The British had hoped to extend their control over their most valuable colony, but China refused to recognize the validity of what it considered unequal treaties forced on it by the British in 1841.

London finally conceded that there was no legal basis to force China to renew the New Territories lease, and that modern-day Hong Kong could not survive without that major portion of the colony, nor without Chinese acquiescence. In 1984, after two years of lame posturing about China's need to honor international treaties, Britain was left with little choice but to agree to China's proposal for a Joint Declaration. Hong Kong would be a Special Administrative Region (SAR), with its own legal and economic systems until 2047, 50 years after its return to China.

The Joint Declaration set a framework to handle bilateral issues between Britain and China. Deng Xiaoping applied the "one country, two systems" (OCTS) formula to the Joint Declaration for the return of Hong Kong to Chinese sovereignty. That formula had been originally fashioned as a solution to the Taiwan problem as a Chinese internal affair. Subsequent to the Sino-British Joint Declaration, Deng approached Washington directly for acceptance of the same formula for solving the Taiwan problem. The administration of president Ronald Reagan summarily turned the idea down as a non-starter. Nevertheless, the OCTS formula became official Chinese policy for the reunification of Taiwan, with wholesale Chinese political compromise on Hong Kong in deference to its implication on Taiwan.

OCTS is a fundamental error of multi-level dimensions on the part of China, not the least of which is Chinese acquiescence on the principle of foreign meddling in Chinese internal affairs. Short-term, it permitted the continuation of neo-colonialism on Chinese soil under Chinese sovereignty for another half century. This was a significant backsliding. Since the 1911 revolution, no colonialism had been allowed to exist under Chinese sovereignty, even though it continued to exist in occupied territories where Chinese sovereignty had been temporarily suspended. One of the two systems referred to in the policy of OCTS is in fact neo-colonialism disguised as capitalism. Furthermore, the system in Taiwan is national capitalism, not colonialism. Thus the policy of OCTS may apply to Taiwan, but not to Hong Kong. Because the policy of OCTS was misapplied to Hong Kong, it gave Taiwan an opening to say it did not apply to Taiwan because Taiwan is not a foreign colony. Thus the policy's original purpose was negated while political compromise on the return of Hong Kong was made for naught.

The reality today is one country: China; two governments: Beijing and Taipei; and three systems: socialism (with Chinese characteristics) on the mainland, national capitalism on Taiwan, and residual colonialism in Hong Kong. The British are gone from Hong Kong administratively, but Anglo-US neo-imperialism continues to rule Hong Kong by proxy through its overwhelming economic prowess.

The events at Tiananmen Square in 1989 altered the geopolitical context affecting Hong Kong. More ominously, Beijing's overture to gain US acceptance of the policy of OCTS opened the way for US interference on the future of Hong Kong. Up to that point, Washington had been officially neutral in a bilateral problem between China and Britain involving the redress of historical colonialism.

After Tiananmen, the issue of Hong Kong was abruptly transformed from one of righteous termination of British colonialism on Chinese soil to official Chinese acceptance of colonial institutions for 50 more years in the name of democracy and free enterprise market fundamentalism. Moreover, the issue of Hong Kong prompted the US Congress to adopt the Hong Kong Policy Act, which provides a legal basis in US law for self-righteous US monitoring on Chinese acceptance of Western democracy and capitalism in Hong Kong and, by extension, within Chinese territory.

US recognition of the People's Republic incurred the price of the Taiwan Relations Act, which binds the US with the force of domestic law to interfere in China's internal affair by helping Taiwan defend itself militarily against reunification by force from China. Similarly, US recognition of Hong Kong under Chinese sovereignty incurred the price of the Hong Kong Policy Act, which also interferes in China's internal affair by holding China to the observance of the OCTS policy with the force of US domestic law. China rejects both these US domestic laws as unacceptable interference in its internal affairs. Yet Chinese policies on Hong Kong and Taiwan are operationally constrained by these two US domestic laws.

Until Hong Kong and Taiwan are free of foreign intervention, China's status as an independent power remains blemished. If the US could unilaterally withdraw from the Anti-Ballistic Missile (ABM) Treaty on the grounds that it no longer served US national interest, why shouldn't China have the same option on OCTS when and if the policy no longer serves Chinese national interest? Because there was nothing Russia could do about US's unilateral withdrawal from the ABM Treaty, while the US can cause economic pain to Hong Kong by denying the SAR its special trade status with the US if the OCTS policy is not observed. The US has no such power over Shanghai, or Shenzhen, or any other city in China.

The British exploited to the maximum this new post-Tiananmen geopolitical climate with the full backing of US moral imperialism. Hong Kong's last colonial governor, Christopher Patten, an ambitious Conservative politician who had earlier lost his seat in parliament, arrived in 1992 to pursue the goal of setting Hong Kong up as an anti-China base by 1997, in the name of democracy as the parting gift of British colonialism. In direct violation of a bilateral understanding of "50 years without change" for Hong Kong, Patten embarked on a crash program of "democratic reforms" in Hong Kong now that British colonial rule was ending by 1997.

This was coupled with the evacuation of century-old British monopolies through inflated financial compensation from government funds. Even the British military was paid handsomely (US$1 billion) for removal expenses, for which the newly installed financial secretary, never given the option to resist, was rewarded with a knighthood for being of service to the British crown. Faithful collaborators with British colonialism were hailed as democratic community leaders and defenders of freedom. The lead member of the Executive Council that "advised" the British colonial governor (Lydia Dunn) was made a baroness for faithfully protecting British interests in the name of preserving freedom for the people of Hong Kong.

In a crash localization program, Patten hand-picked key locals to lead the civil service. Well-trained running dogs such as Anson Chan were groomed to head the allegedly apolitical civil service, with a strategy aggressively focused on insulating Hong Kong from any influence by China. Key civil servants were sent to Harvard University's Kennedy School of Government for special indoctrination in the basics of neo-liberal governance, complete with sham degrees and diplomas. Neo-liberalism replaced old-time colonialism, introducing a neo-colonialism of US economic imperialism under the pretext of preserving Hong Kong as an international city with the rule of law, free enterprise, press freedom, small government - scripts written by the Heritage Foundation and the American Enterprise Institute. This fantasy is in direct contradiction to the historical fact that Hong Kong was never more than a British colony structured to serve British geopolitical and economic interests and to enrich British monopolies through a British command colonial economy.

After the signing of the Joint Declaration in 1982, Hong Kong, still under British rule, wasted 15 years prior to its return to China, with no long-range plan to deal with the new geopolitical landscape. Hong Kong hung on to fantasies created by Anglo-US propaganda, totally intoxicated by a bubble economy created by its currency peg and a trade regime heavily dependent on geopolitical preference. While in office, Patten, working feverishly to cater to US ideological fixation, ran what British career diplomats in Whitehall labeled a sideshow, oblivious to British interest in, and need for, good long-term Sino-British relations. While Britain had no power to resist Chinese demands, the US had its trade card on both Hong Kong and China.

The agreement of "50 years without change" was surreptitiously rendered meaningless by Patten's stealth change in the political structure of Hong Kong to make the SAR ungovernable after 1997. A so-called Democratic Party with only a handful of members was formed with open US support to oppose China in the name of liberty. It was the latest version of the British strategy of perpetuating "divide and rule" in its involuntary decolonization program throughout the shrinking British Empire. On the issue of the rule of law, British common law, which was practiced only within former territories of the British Empire and not in former territories under continental civil law of the Napoleonic Code, was allowed to continue in Hong Kong under Chinese sovereignty. Yet the arrangement of the highest judicial authority resting previously in the Privy Council in London was not reciprocated by transferring that authority to the People's Supreme Court in Beijing. Hong Kong was allowed to set up its own Court of Final Appeal. This bizarre arrangement promptly produced a constitutional crisis over the issue of sovereignty in Hong Kong soon after its return to China.

As China adopted its "open to the outside" policy in 1979, Hong Kong and China both soon reaped the immediate benefits of the colony's early participation in the modernization of China. Hong Kong entrepreneurs were able to provide expertise and capital for joint venture projects on the mainland, beginning with tourism and hotels, and soon moving into infrastructure and manufacturing. As a result of this collaboration, China in return increased and changed the types of investments it had made in Hong Kong up to then. For example, in the 1970s Chinese investments in Hong Kong were mainly centered on transport, shipping, finance and distribution of Chinese export goods beyond Hong Kong. These investments were targeted to serve the needs of a still largely closed Chinese economy. By the early 1980s, investments began to include a cigarette factory, real estate and related businesses, department store chains selling mainland products, printing presses, periodicals and gas stations. These investments were focused on trading profits, beyond serving the needs of a closed economy on the mainland. China Resources, which had organized Chinese export trade through Hong Kong, evolved into a huge conglomerate. Chinese banks and insurance companies formed joint ventures with Hong Kong investors.

Between 1976 and 1981, the value of Hong Kong's domestic exports to China multiplied 120 times. The amount of Chinese goods re-exported from Hong Kong - then acting as China's only "door to the world" - comprised 31 percent of the colony's total in 1981. Today, Chinese companies and financial institutions are major players in the Hong Kong economy. Clearly, both sides enjoyed a significant increase in trade as a result of Hong Kong's effort to profit from helping China reach its goal of modernization through economic growth.

But the adverse effect on China has been the acceptance of Hong Kong's colonial economy as a model of reform for the Chinese economy. By learning about the modern world after five decades of near-total isolation through the warped experience of colonial Hong Kong, China modeled the first phase its modernization as a revival of a semi-colonial regime that the nation had endured two political revolutions to throw off. This key compromise poisoned Deng's "Four Modernizations" program and sowed the seeds of corruption in all levels of Chinese government and society and of ideological decay within the Communist Party. The Chinese economy fell into the trap of excessive dependence on exports to the West, primarily to US markets, by building a sweatshop economy along the Hong Kong model, and on foreign capital, along the path welcomed by Western imperialism. It would have been arguably acceptable as a short-term compromise for the "take-off phase" of economic development. But the export frenzy went on for 25 years at the expense of balanced domestic development, in the process letting a social services and health network and a regime of equitable distribution of wealth that had been the envy of the world deteriorate into chaos and decadence.

The adverse impact of compradore culture and associated corruption on the ideological erosion of the Chinese Communist Party was allowed to become structural. It is only recently that China has begun to refocus on internal development, away from exports, to address the imbalance between the coastal regions and the interior, to stimulate domestic consumption and to correct the problem of extreme disparity of income and polarization of wealth. On the issue of foreign capital, China has yet to apply the principle of creditary economics based on the State Theory of Money to free itself from dependence on foreign capital for domestic development. On the ideological front, the noble aspiration of serving the people has been replaced by the crass aim of serving foreign capital for profit. Getting rich at the expense of the people is not glorious, even under capitalism.

The Nazis came to power in 1933 in Germany at a time when its economy was in total collapse, with ruinous war-reparation obligations, and zero prospect for foreign investment or credit. Yet, through an independent monetary policy of state credit and a full-employment public-works program, the Third Reich was able to turn a bankrupt Germany into the strongest economy in Europe within four years, even before armament spending began. While this observation is not an endorsement for Nazism, the effectiveness of German economic policy in this period, some of which had been started during the last phase of the Weimar Republic, is undeniable.

China's pace of growth in the past two-and-a-half decades has been much touted by Western neo-liberals. Yet a case can be made that China's growth rate had been unnecessarily slow, that despite self-congratulatory complacency, China is still falling behind world standards on many measures even by its own projections. And this relative slow growth is not caused by the absence of liberal markets but by China's mistaken view that a disadvantaged participation in neo-liberal globalization is its only option.

It is time for China to realize that acceptance of this fate is not ordained by nature. Furthermore, the economic growth came with the price of unsustainable structural imbalance, malpractice in human-resource utilization and environmental management, and continuing transfer of the nation's wealth overseas through export under dollar hegemony. This self-arresting sluggish growth rate is in large measure the result of the undue influence on China's development strategy exerted by the colonial-economy mentality of Hong Kong tycoons. Such a mentality sees subservient support for economic neo-imperialism in the form of neo-liberal globalization as the only option for growth, instead of the game of voluntary perpetual indenture that it actually is.

Hong Kong's balloon economy had boomed with its new China trade beginning in 1978. By 1987, it recorded a 13.6 percent annual gain in gross domestic product (GDP). On Black Monday, October 19, 1987, the Hong Kong stock market, alone among the world's financial centers facing contagious global collapse, closed for four days. The British Hong Kong government had to use HK$4 billion (US$513 million) to rescue the Hong Kong Futures Exchange from insolvency. The international press called the Hong Kong stock market under British regulatory supervision "a badly run casino".

On the other side of the globe, Alan Greenspan, newly appointed chairman of the US Federal Reserve Board, built his reputation by releasing a single sentence that said he would supply all the liquidity the banking system needed to stay afloat after the 1987 crash. He pumped tens of billions of US dollars, a fiat currency that he could print at will, into US financial institutions by pushing down the overnight lending rate aggressively. Greenspan's move flooded financial markets with money, which helped preserve liquidity and restore confidence in the US financial system, but it started the bubble economy of the 1990s, which ended in Asia on July 2, 1997, one day after Hong Kong was returned to China. Greenspan did in essence the same thing in 1998 and again after September 11, 2001. Greenspan will go down in history as the central banker who revived moral hazard.

When the Asian financial crises began in Thailand on July 2, 1997, the new SAR government maintained with hubris that the fundamentals of Hong Kong's economy were sound. It had US$112 billion in foreign reserves, no external debt, a currency pegged to the US dollar, low taxes, business-friendly government, rule of law, freedom of information, etc, etc. Hong Kong was confident enough to contribute US$1 billion to the International Monetary Fund to help contain the crisis within Thailand. Government leaders were calmly announcing that all Hong Kong needed was to stay the course and keep its "confidence" in what they mistook as a passing storm. They were painfully oblivious to the fact that staying the course would lead Hong Kong directly toward a whirlpool of economic collapse in not a passing storm but a fundamental structural collapse of the neo-liberal global financial architecture. They were also blind to the fact that the Hong Kong economy's easy ride on the geopolitical magic carpet was coming to an end.

The neo-liberal mantra began to sound like empty pitches of snake-oil pushers on the Cross Harbor Ferry. No one could answer the embarrassing question: with such good fundamentals, why are the factual data so consistently bad and for such a protracted period?

By August 1998, the SAR government had to intervene in the Hong Kong stock market, buying up more than US$15 billion in publicly traded blue-chip stocks to fend off speculative attacks on the Hong Kong dollar. Since 1997, Hong Kong has been locked in a downward spiral by staying the course.

All kinds of harebrained schemes surfaced. The government used US$1.74 billion of public funds to lure the Disney Co to Hong Kong, at a time when Disney has been facing financial problems worldwide, and the potential of theme parks as a development stimulant having visibly peaked. Hong Kong Disneyland Phase 1 will include a Disney theme park, Disney-themed hotels and retail, dining and entertainment facilities. It will occupy 126 hectares, and can be expanded to 180 hectares in the future. Phase 1 is expected to open in 2005. The project involves a total commitment of HK$22 billion (US$2.8 billion) in public funds (infrastructure, loans and equity). In its first full year of operation, Hong Kong Disneyland is expected to attract more than 5 million visitors, including 1.4 million new tourists, and stimulate additional spending of HK$8.3 billion. The government claims that over a 40-year period, the project is expected to generate economic benefits amounting to HK$148 billion. Any Hong Kong entrepreneur would tell you that a sixfold return over a 40-year period is hardly a financial gold mine, notwithstanding that the estimated return is denominated in soft "economic benefits", not hard cash.

In all, Hong Kong has proposed some US$77 billion in government-supported infrastructure and other major projects over 15 years, intended to get the stagnant economy moving again. That is massive by any standard - amounting to US$12,000 per resident, about 50 percent of 2001 per capita GDP. But many of these proposed projects fail to coordinate with mainland development plans, let alone fully integrate with them, if not in predatory competition with the Pearl River Delta economy. Hong Kong's vision of itself as the front parlor for entertaining foreign investors and the well-appointed sales office, with the Pearl River Delta as the servants quarters and the factory floor, has not been well received by mainland officials. Many of Hong Kong's plans have to do with keeping the Pearl River Delta from effectively competing with Hong Kong rather than true cooperation on an equal basis for mutual benefit. This is because compradorism does not thrive on equality. It is also the mentality behind Hong Kong's insistence of not wanting to be a "Chinese" city, a view relentlessly expressed by Patten protege chief secretary Anson Chan until her "early retirement".

Such grand schemes have pushed public spending up to 24 percent of GDP, producing a budget deficit while contributing little to constructive restructuring of the Hong Kong economy, which requires full integration with the mainland economy. In the manner that SAR government Requests for Proposals are written, many of the construction and consulting contracts will go to foreign firms in the name of an open market, at a time when the local unemployment rate is over 7 percent, inching toward 9 percent by most forecasts. Also, the thinning demand for local professionals further exacerbates the ongoing brain drain from Hong Kong.

In 1997, when the British returned Hong Kong to Chinese sovereignty, public expenditures accounted for just 17 percent of GDP, albeit calculated on a substantially larger GDP. From 1998-99 to 2001-02, government expenditure recorded a cumulative growth of 17 percent in money terms, while GDP registered a cumulative fall of 5 percent. Public expenditure in the economy averaged about 16 percent in the mid-1980s, about 17 percent in the mid-1990s, but rose to 22 percent in 2001-02. In the face of economic downturn since 1997, the SAR government has consciously adopted a counter-cyclical fiscal policy, keeping expenditure growth above the projected growth trend of the economy. But the government's fiscal stimulant has been focused on ineffective spending, neglecting unemployment and public housing, and integration with the mainland economy. The government has recently cut social welfare payments by 11 percent and in effect reduced the minimum wage for new contracts of foreign domestic helpers by about the same. A recent deal with civil servants will cut their salaries by 6 percent in two stages.

In addition, price rigidity in public-expenditure contracts causes prices to continue to rise despite general deflation in the economy. The government's stated target is to reduce public expenditure to 20 percent of GDP or below by 2006-07. Unless this reduction is achieved through a rise in GDP rather than a cut in public expenditure, it will further distress the economy.

Land premium, constituting 22.6 percent (HK$63.6 billion) of revenue in 1997-98, fell to 4.4 percent (HK$8.5 billion) in 2002. This is the center of the problem. Hong Hong's export partners are mainland China (34 percent), the United States (23 percent), Japan (6 percent), Germany (4 percent), the United Kingdom (4 percent), Taiwan (3 percent), and Singapore (2 percent), with China trade expected to be the leading growth potential. Yet a proportional share of public expenditure has not been directed toward further integration with China.

With the outbreak of the Asian financial crisis in the second half of 1997, the Hong Kong economy suffered severe setbacks, and for the first time in recent memory it recorded negative growth on an annual basis in 1998. The economy rebounded temporarily and attained double-digit growth in 2000 on naive and false expectation that what went down must go back up. But along with the global economic downturn, the Hong Kong economy slowed abruptly again in 2001. The Hong Kong economy yielded growth averaging only about 2 percent per annum between 1998 and 2002. Yet China, Hong Kong's largest trading partner, consistently registered growth rates above 7 percent in the same periods. This disconnect is largely the result of Hong Kong's failure to integrate its economy with the mainland economy.

And there is serious talk of new taxes in Hong Kong, including one on border crossing to the mainland and a new tax on goods and services. New taxes are always unpopular, especially in a traditionally tax-shy city with a maximum 15 percent tax rate on personal salary income and a 16 percent tax on business income. Most in Hong Kong pay no salary income tax at all and only 13,000 people in a city of 7 million pay the peak rate of 15 percent. But the real regressive impact is the obstacle such border-crossing taxes erect against the needed integration of the two economies.

Disparity in costs between Hong Kong and the Pearl Delta is about 10:1 at present. Integration with the Pearl Delta would require Hong Kong costs, particularly wages and rent, to fall drastically even as Pearl Delta costs rise. This cost disparity vastly exceeds that between West Germany and East Germany or that between New York and New Jersey. Since the opening up of the mainland in the 1980s, Hong Kong enterprises, leveraging the low costs there, have expanded their production capacity and enhanced Hong Kong's cost competitiveness globally. Hong Kong's domestic economy has upgraded itself in tandem with its exploitation of low labor and land cost on the mainland. But Hong Kong has been siphoning off most of this profit, only a small portion of which has been reinvested on the mainland. Even then, the reinvestment has been concentrated in more sweatshop production for more export, rather than in socio-economic development. The rest of this profit has been going into bidding up real estate prices in Hong Kong and into money-losing real-estate investment in the US, Britain, Canada and Australia in the form of flight capital through most of the 1990s. In recent years, profit from Hong Kong has been poured into wireless and telecommunication ventures overseas, with unhappy results.

Support services for the Hong Kong trading sector and its mainland factories replaced the local manufacturing sector as the fastest-growing sector. The South China region has now evolved into one of the world's prolific production bases. Since the mid-1990s, service industries on the mainland have also been developing apace. During this period, a bubble economy emerged in Hong Kong, giving rise to high operating costs in the colony, pushing some Hong Kong service industries to move northward as well. Moreover, after its return to China, Hong Kong residents, in increasing numbers, travel across the boundary to shop and vacation, adversely affecting Hong Kong's domestic consumption and the retail sector and its real-estate base.

In the process of economic integration, the price differential between Hong Kong and the mainland will inevitably narrow gradually through factor price equalization. The price of tradable products should adjust swiftly because of relatively free trade between the two economies. But fixed rents in Hong Kong prevent this adjustment from taking shape without widespread business failures and bankruptcies.

The adjustment of non-tradable factors such as land and labor will be slow and painful. However, factor price equalization does not mean that price levels between Hong Kong and the mainland will be the same, just as New York, London and Tokyo have relatively higher prices than their neighboring areas. Prices in Hong Kong will generally remain higher than prices in the Pearl Delta for some time, but the exponential gap cannot remain forever. The conventional wisdom is that the magnitude of this price differential will hinge largely on Hong Kong's ability to provide high-value-added services and goods. But God has not forbidden the Pearl River Delta from developing high-value-added service and goods production. Ironically, the high cost disparity gives more of a boost to the Pearl River Delta's downhill effort to develop such services and goods than to Hong Kong's uphill effort to maintain the cost differential.

As the bursting of the bubble economy coincided with economic restructuring, Hong Kong has experienced heavy deflationary pressure, exacerbated by the linked-exchange-rate mechanism tied to a US dollar that, despite its recent decline, is still overvalued. Hong Kong property prices have dropped from their peak by more than half. And because of the economy's disproportionate reliance on the real property sector, this has magnified the economic crisis. High labor costs in Hong Kong force pay cuts and layoffs, causing high unemployment and underemployment, which in turn reduces domestic demand, particularly consumer spending, as well as incentives for more education and training, shrinking the economy further in a downward spiral.

China's growth so far is based on labor-cost advantage in the global export market, coupled with low land costs and environmental liabilities. Even then, the growth rate is unsustainable on exports alone as the global economy stagnates and global trade shrinks. To keep the growth rate above 7 percent, China would have to focus on domestic development. Hong Kong's future rests on its role in China's domestic development.

Shenzhen, the Special Economic Zone (SEZ) just north of Hong Kong, is keeping a close watch on its cost structure to ensure that it does not escalate to levels that have weakened Hong Kong's competitiveness. Increasingly, other Chinese cities, including Shanghai, are using Hong Kong as a model to avoid, rather than to emulate.

The Hong Kong government budget deficit at the end of the financial year in March was a record amount that represents more than 5 percent of projected 2003 GDP. It was far above the original estimate, mainly because government revenue was 19.2 percent less than originally estimated. Moody's, a major international rating agency, has estimated the 2003 deficit to be as high as HK$90 billion. Government revenue will continue to shrink, as the bulk of it comes from land revenue. Since Hong Kong has no capital-gains tax, there will be an adverse impact on revenue from salary income as Hong Kong shifts wage-earning activities to the Pearl River Delta. The currency peg is a hindrance to economic recovery and cannot hold, notwithstanding government intransigence on the issue.

Local polls on top popular concerns repeatedly show democracy trailing by wide margins major livelihood issues, such as rising unemployment, small business bankruptcies, home mortgage foreclosures, education, crime and public health. The chief executive has introduced a mild form of industrial policy that will help the SAR compete in select, strategic industries. Hong Kong is now solidly dependent on its ability to integrate with the rest of China's economy.

The effect from exports on the domestic sector has been weakening in the past 20 years. Less than 30 percent of the working population is now in trade-related fields. Domestic demand is still very weak as the local economy has yet to recover from the severe wounds of the economic crisis and all disposal income has been soaked up by real estate costs, depleting purchasing power even for the still employed.

China feels the need to support the stagnant Hong Kong economy to prevent the link between Chinese sovereignty and economic depression, but is rather helpless because Hong Kong's Basic Law, its mini-constitution, specifically forbids Chinese interference in Hong Kong. Yet the cause of Hong Kong's economic woes has little to do with Chinese sovereignty. It has to do with Hong Kong's delusion about its geopolitical free ride as a free market, made inoperative after 1997 when the United States abandoned preferred trade treatment for Hong Kong for lack of geopolitical incentive now that it is part of China. But the mainland economy is thriving. Hong Kong's economy is in trouble not because it is now under Chinese sovereignty, but because Hong Kong refuses to be Chinese. Why should China feel the need to defend residual colonial compradorism in Hong Kong, which claims superiority over socialism with Chinese characteristics on the mainland?

Hong Kong's self-styled central banker, Joseph Yam Chi-kwong, head of the Hong Kong Monetary Authority, whose central bank function has in effect been stripped by the peg, recently warned publicly in writing that "a fiscal deficit carries the risk of leading to an interest-rate shock if a budget package lacks credibility or community support". Since the Monetary Authority operates under the direct control of the Financial Secretary, one can assume that its head was speaking for the government. The message is clear that the danger of a budget deficit is directly related to the defense of the currency peg. In other words, the peg is preventing Hong Kong from using a fiscal deficit to counter the most difficult economic crisis, despite the fact that Hong Kong has more than US$100 billion in reserves. Yam is an open admirer of Alan Greenspan, whose style Yam tries hard to emulate, notwithstanding the difference in background and training between the two. But Greenspan is flooding the US, and by extension the world, with US dollars that he can print at will, and in fact threatening to print more to fight deflation and to support President George W Bush's $300 billion deficit. But Yam, with US$120 billion in reserves, is unable to tolerate an US$11 billion deficit because of the peg.

An interest-rate shock resulting from an attack on the peg in 1997-98 pushed Hong Kong dollar inter-bank rates far above their US dollar equivalents and sent the Hong Kong economy into a tailspin. Hong Kong is not Argentina, which has been done in with dollar debts and its currency peg. But it is acting like Argentina with its budget crisis.

Yam also warned that the ability of Hong Kong's banks to absorb such an interest-rate shock without adjusting their lending rates has been eroded in recent years by greater competition and lower profitability. Thus the government is acknowledging that a free credit market is detrimental to Hong Kong's financial wellbeing.

On November 12, the Heritage Foundation and the Wall Street Journal released the 2003 Index of Economic Freedom. The Index is an annual survey of the world's economies, including country-by-country analyses and the most up-to-date data available on foreign investment codes, taxes, tariffs, banking regulations, monetary policy, black markets, and more. For the ninth consecutive year, Hong Kong was named the world's freest economy. The Heritage Foundation rates Hong Kong No 1 in its index of economic freedom and the People's Republic of China No 127. Apparently, freedom is inversely related to growth rate.

In 2001, Hong Kong's GDP was US$162.6 billion with an export value of $201.9 billion. The Pearl River Delta had a GDP of $258 billion with an export value of $289.1 billion. The growth rate differential between the two is 15:1 in favor of the Pearl River Delta. For Hong Kong to be calling the shots for the future of the region would be the tail wagging the dog.

Concerted efforts have been made by the government to promote and position Hong Kong as Asia's world city. The Brand Hong Kong program, launched in May 2001, is billed as a long-term undertaking to focus greater international attention on Hong Kong's strengths and advantages as the most free, open and cosmopolitan city in Asia. In July 2000, the government established a dedicated department, Invest Hong Kong (InvestHK), to spearhead efforts to attract inward investment. InvestHK actively promotes Hong Kong as the premier business hub in the Asia-Pacific region, and as the best location to access the enormous potential of the mainland market. The government's message to the world is that major reasons companies are attracted to Hong Kong are low and simple taxes, the free flow of information, political stability and security, corruption-free government and excellent communications, transport and other infrastructure. But the real reason is the potential of the China market.

Central to Hong Kong's long-term success is greater economic cooperation and inter-dependence with the adjoining Pearl River Delta hinterland, which has specific advantages and significant potential as a consumer market, a trading hub, a manufacturing base, a services market and as a destination for investment. An economy cannot be sold like brands of cigarettes or diapers. If fundamentals behind prosperity are missing, no amount of selling will make up for a delusion of grandeur. Hong Kong will do better to spend its money where it counts, such as a full-employment program.

The Pearl River Delta, which includes Hong Kong and Macau, is the fastest-growing and most affluent region in China. It has a population of about 48 million, which is more than the populations of Canada, Taiwan or Malaysia. The Pearl River Delta has a GDP of US$258 billion - more than Switzerland, Sweden or Austria - which would put it among the world's top 20 economies. Hong Kong has helped fuel the Pearl River Delta's rapid growth and development over the past two decades. Hong Kong is the largest investor in the area, and there are more than 36,000 Hong Kong-linked companies employing more than 5 million people in Guangdong province.

Despite the depth and breadth of these links, there is a need to boost significantly cross-boundary cooperation and integration to build on existing strengths and synergies and maximize the area's potential. The emphasis is on free flows of people, goods and capital between the Hong Kong SAR and the Pearl River Delta's major cities, which include Guangzhou, Shenzhen, Zhuhai, Zhongshan, Dongguan, Foshan, Huizhou, Huiyang, Huidong, Zhaoqing and Jiangmen as well as Macau. This cannot be accomplished with Hong Kong setting itself apart as an autonomous and non-Chinese entity.

Yet not until last July did Hong Kong's first Economic and Trade Office in the mainland open in Guangzhou to promote economic cooperation and to strengthen business and economic liaison between Hong Kong and the Pearl River Delta.

The chief executive, Tung Chee-hwa, announced in his Policy Address in October 2001 an ambitious infrastructure plan worth HK$600 billion (US$77 billion). Of this, one-third would be spent on expanding the railway network to make it the backbone of Hong Kong's public transport system. From 2002 to 2007, six new rail projects costing US$13 billion (HK$100 billion) will come on line at a rate of about one a year. The existing railway network will be expanded by 40 percent to more than 200 kilometers. Urban areas will be connected with new towns in the eastern and northwestern parts of the New Territories. Yet there were no priority projects to improve linkage with the mainland until recently. A second rail passenger boundary crossing at Lok Ma Chau will be developed to handle the substantial growth in two-way travel and commerce across the boundary, but no target date has been announced. By contrast, a dedicated rail link will be built to Hong Kong Disneyland, due to open in 2005.

Plans are being developed for another six new rail projects before 2016. These include a Port Rail line linking the container port at Kwai Chung with the railway network in the Pearl River Delta and a high-speed railway linking Hong Kong to Guangzhou via Shenzhen. The year 2016 is 13 years in the future.

Over the next decade, more than 100 kilometers of major trunk roads will be constructed and improved, including the Deep Bay Link and the Shenzhen Western Corridor. Total investment on these projects will be more than HK$100 billion. The proposed Shenzhen Western Corridor will provide a strategic link between Hong Kong and Shenzhen across Deep Bay. It is an integral part of the infrastructure being put in place to provide more and faster cross-boundary links with the mainland to expedite the flow of people, cargo and capital between Hong Kong and the Pearl River Delta. Again, no target completion date has been announced.

Hong Kong has one of the world's busiest boundary crossings. In 2001, about 106 million people and 11.3 million vehicles crossed back and forth between Hong Kong and the mainland. Every day, an average of about 313,000 people and more than 31,300 vehicles cross back and forth between the Hong Kong SAR and the mainland, with most people heading into neighboring Guangdong province.

Container Terminal 9 (CT9), now being built on Tsing Yi Island by the private sector, is aimed at consolidating Hong Kong's position as the world's busiest and most efficient container port. The 68-hectare project will have six berths and a design capacity to handle more than 2.6 million 20-foot-equivalent units (TEUs) a year. CT9 is expected to be completed in 2004, and will bring annual total capacity at the Kwai Chung Container Terminal Basin to more than 15 million TEUs. The new marine basin will be able to handle the largest container ships currently on the drawing boards. Yet the private interests behind these projects have emerged as the most vocal and influential opposition to logistic integration with the Pearl River Delta. A proposal for a 15 billion yuan (US$1.83 billion) bridge linking Hong Kong, Macau and the mainland Chinese city of Zhuhai, which neighbors Macau, has sparked bickering among Hong Kong tycoons over their special interests (see The New York of Asia: Port in a storm.

The container-terminal industry, speaking through the powerful Hutchison Whampoa Group, opposes moves that may affect the current governmental arrangement of privately developed container terminals. The Hong Kong Container Terminal Operators' Association, which represents private terminal operators, including Wharf's Modern Terminals, CSX World Terminals and Hutchison Whampoa's Hongkong International Terminals, while claiming not to be against the bridge project, was quoted by the press as being opposed to "proposals that changed the government's port development policy so as to create an unfair situation for the existing players".

The proposed bridge would be a regional infrastructure that would be key in integrating Hong Kong and the Pearl River Delta into one vibrant regional economy. In that sense, would be vital to the economic survival of Hong Kong and beneficial to Guangdong province and China in general.

Shenzhen's port reported fast growth last year. The SEZ port handled about 87.67 million tons of cargo and 7.62 million TEUs, representing a 32 percent increase in volume and a 50.1 percent growth in container throughput. The figures elevated Shenzhen ahead of Los Angeles and Rotterdam to become the world's sixth-busiest container port in 2002.

Hong Kong remained the world's busiest container port and handled an estimated 19 million TEUs in 2002 - a 6.6 percent increase over 2001. Shenzhen aims to increase its container-handling capacity to 11 million TEUs by 2005 and 18 million TEUs by 2010.

Shenzhen airport's passenger and cargo traffic increased 20 percent and 35 percent year-on-year respectively in 2002. Passenger numbers jumped to 9.35 million, while cargo volume leaped to 334,100 tons. By comparison, Hong Kong International Airport's growth was slower - passenger numbers grew 4.5 percent to 33.5 million in 2002, while cargo traffic was up 19.5 percent to 2.5 million tons. Shenzhen airport operated 120 domestic and nine international flight routes in the year, whereas Hong Kong had 130, of which 40 were to and from the mainland.

The number of mobile-phone users in Shenzhen increased to 6.05 million in 2002 from about 3.88 million in 2001. Some 174 fixed-line and mobile phones are owned by every 100 residents in Shenzhen in 2002. During the year, the SEZ's Internet user numbers surged to 1.88 million, from 1.06 million in 2001. Hong Kong had about 6.22 million mobile-phone users in 2002, up 82 percent over the previous year, representing a penetration rate of about 91 percent. Registered Internet users in the SAR totaled 2.36 million in 2002. But Hong Kong's population is about 6.8 million while Shenzhen's is about 4.7 million. Taking this into consideration, Shenzhen had caught up with Hong Kong in telecommunications. Both Hong Kong and Shenzhen have reached saturation in telecom market growth. Future growth would come from other cities in the Pearl River Delta. Shenzhen's gross domestic product grew 15 percent last year to 223.9 billion yuan, enabling per capita GDP to reach US$5,561 (HK$43,376), the highest in the mainland.

Hong Kong government revenue has fluctuated wildly between 14 percent and 21 percent of GDP in the past decade, largely affected by volatile land lease revenue. The government's long-term fiscal strategy and tax reform needs to address issues related to its excessive dependence on land lease revenue and the narrow tax base.

The performance of companies involved in real estate in Asia has lagged far behind those in non-real-estate sectors since 1997. In Hong Kong, the five-year average return on capital employed for non-property sectors since 1997 was 17.3 percent, compared with merely 6.7 percent for diversified firms with both property and non-property businesses and only 6.5 percent for real-estate companies. The listed companies in Hong Kong that have done well since 1997 are the ones with heavy investment in China.

Even the British-dominated Hong Kong General Chamber of Commerce has been urging the SAR government to listen more to the business community on economic integration with the Pearl River Delta. Chamber director Eden Woon, a US citizen and a former US Air Force intelligence officer, said he was pessimistic about the government's handling of issues concerning integration with the Pearl River Delta. He complained that businessmen generally did not have enough say in such issues as cross-border infrastructure, environmental protection and immigration policies. Woon called on the government to set up a "Greater PRD Council", an unofficial forum like the Asia Pacific Economic Cooperation (APEC) forum, in which council members would meet annually to discuss business issues of delta integration. Under a proposal Woon handed recently to the government, several committees would be set up to deal with key issues. Michael Enright, co-author of The Hong Kong Advantage and a professor at the School of Business at the University of Hong Kong, notwithstanding the embarrassment of the mysterious disappearance of the so-called Hong Kong advantage, echoed Woon's views.

The proposal of Woon and Enright of an APEC-type forum, a loose coordination body of private interests from different sovereign states, would further reinforce the separation of the Hong Kong from the Pearl River Delta by treating the two Chinese entities as de facto sovereigns.

While Adam Smith realized the growing importance of capital in economic progress, he also was apprehensive of the growing danger of its abuse. His attitude of distrust toward the capitalist as an advisor of government has been clearly stated: "The interest of the dealers in any particular branch of trade or manufactures is always in some respects different from and even opposite to that of the public. The proposal of any new law or regulation of commerce which comes from this order of men ought always to be listened to with the greatest precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous but with the most suspicious attention."

The SARS crisis shows that far from wanting smaller government, the public wants stronger government leadership and action, to improve public hygiene and health services, to reduce unemployment, to help small businesses in distress, to revitalize the economy with full integration with the mainland.

Three things have been made clear by the severe acute respiratory syndrome (SARS) crisis: 1) People when frightened look to the government for help. People want more government, not less, in times of crisis. 2) People are prepared to give up freedom for protection, especially when they never enjoyed freedom under colonialism to begin with. 3) Everyone wants government intervention to save the market; no more laissez faire, which never existed under colonial command economy. Bottom line: when things get tough, people want more socialism.

With 30,000 people lining up to apply for 3,600 openings, to call it a crisis is an understatement. The "round up the usual suspects" approach will not be enough.

The government has announced that US$128.2 million will be set aside to promote Hong Kong and to encourage the return of exhibitions, to get trade activities back to normal after the spread of the SARS crisis is brought under control. The government has also announced it will create 21,500 training places and short-term jobs to strengthen service training in the most SARS-affected areas. These jobs will provide home-cleaning services for the elderly and boost environmental hygiene. The program will cost about US$55.12 million. This public-health budget is less than half of the government's public-relations budget. The government will do well to reverse the priority. What is needed is a full-employment program to improve environmental hygiene and other community services (see On offer: A full employment program for Hong Kong by Henry C K Liu and L Randall Wray, March 30, 2002).

Chief Executive Tung Chee-hwa has been the target of political attack by the so-called Democratic Party members in the Legislative Council, blaming him for alleged incompetence and weak leadership in this period of economic crisis. These individuals were noticeably docile and silent during colonial rule. What kind of democratic party is it that has only 590 members, with a chairman who never faced even token elective challenge from the party's founding in 1994 to his voluntary retirement in 2002? And they have the nerve to accuse the chief executive, who has faced two elections since 1997 in accordance with election procedures stipulated by the Basic Law, of being not democratically elected? But most hypocritical of all is that the loud opposition from this party of 590 to Hong Kong's integration with the mainland is one reason Hong Kong is in such a state of economic paralysis.

Tung is an honest, hard-working, conscientious and patriotic leader that any city would be lucky to have. If anything, he is excessively democratic, trying to represent fairly all the diverse and often opposing interests in the community and overseas. His constitutional authority is much weaker than that of the British colonial governor, who enjoyed total dictatorial power, unchecked by any Basic Law, and with the colonial judiciary system in his pocket.

Hong Kong's economic woes are the result of a paradigm shift in geopolitics, not poor leadership. Hong Kong's problems are not made by Tung Chee-hwa, nor can he be expected to solve them without Hong Kong waking up to the geopolitical reality that its fate is tied to its willingness to be an integral part of the motherland. The people of Hong Kong should unite behind Tung to let him lead Hong Kong into an era of renewed national pride and prosperity.