CHINA’S INTEGRATION INTO THE WORLD ECONOMY AND IMPACT ON ECONOMIC LINKS WITH HONG KONG LI JUN NATIONAL UNIVERSITY OF SINGAPORE 2004 CHINA’S INTEGRATION INTO THE WORLD ECONOMY AND IMPACT ON ECONOMIC LINKS WITH HONG KONG LI JUN (B.ARTS, SHANDONG UNIVERSITY) A THESIS SUBMITTED FOR THE DEGREE OF MASTER OF SOCIAL SOCIENCES DEPARTMENT OF ECONOMICS NATIONAL UNIVERSITY OF SINGAPORE 2004 ACKNOWLEGEMENTS I am in debt to my supervisor, Associate Professor Wong Chung Ming, for his precious comments and suggestions given to the entire thesis, his patient and generous guidance on my daily research Without his help, I would not be able to complete my study and finish the thesis at last I wish to express my gratitude to Dr Jose Tongzon for his advice on research topics and Dr Zhang Zhao Yong who supplied me with the information on collecting the data I am also grateful to all those who have given me useful advices and information during the period of my research The person whom I definitely should give my most thankful feeling is my dearest mother She has encouraged me to insist on completing my study even though she has been seriously ill Her love and courage is always my motive to everything I also thank my father who has supported me on studying overseas all the time I have appreciated much Mr Xu Yan’s generous help and care first midst and last Last but not least, I want to thank all my friends who have helped in one way or another to make my life pleasant during the course of the preparation for the thesis i TABLE OF CONTENTS ACKNOWLEGEMENTS i TABLE OF CONTENTS ii LIST OF TABLES iv LIST OF FIGURES vi SUMMARY viii Chapter Introduction Chapter Trade Reform in China and Integration with Hong Kong 2.1 Trade Reform 2.2 Geographic & Commodity Composition of China’s Foreign Trade 2.2.1 Geographical Distribution of China’s Foreign Trade 2.2.2 China’s Revealed Comparative Advantages and Its Exports Expansion 11 2.3 Trade Flows between China and Hong Kong 17 2.3.1 General Theory of Economic Integration 19 2.3.2 Economic Integration Process in China and Hong Kong Economies 21 2.4 Hong Kong-China Trade: Presence of Economic Integration 23 2.4.1 Methodology 28 2.4.2 The Main Results 35 2.5 Conclusion 51 Appendix 53 Chapter Foreign Investment in China and Hong Kong’s Contribution 56 3.1 The Evolution of Foreign Direct Investmet-Related Policies and Foreign Investment Development in China 63 ii 3.2 Mainland Chinese Investment in Hong Kong 68 3.3 Hong Kong’s Investment in China 70 3.4 Regional Distribution of Foreign Direct Investment from Hong Kong to China 75 3.5 The Foreign Invested Enterprises in China 84 3.6 Conclusion 92 Chapter The Development, Problems and Perspective of Guangdong – Hong Kong Economic Link 95 4.1 Guangdong in the Context of Reform in China 96 4.2 Guangdong – Hong Kong Production Connection 100 4.3 Developmental Problems in the Economic Linkage of Hong Kong and Guangdong 104 4.4 Analysis of Future Developing Strategies of Guangdong and Hong Kong 107 Chapter Concluding Remarks 113 5.1 Main Conclusion of the Thesis 113 5.2 Problems with the Development of China’s and Hong Kong’s Economy 115 5.3 Prospects for China’s Economic Development and Hong Kong’s Role 120 References 127 iii LIST OF TABLES Table 2.1 Volume of Imports and Exports in China, 1978-2002 (US$ billion) Table 2.2 Geographical Distributions of China’s Exports and Imports, 1980, 1990, and 2001 (%) 10 Table 2.3 Revealed Comparative Advantage Indices (Exports), China and Comparator, 1980-1996 13 Table 2.4 Changing Commodity Shares of Selected Labor-intensive Goods, 1980, 1990 and 1996 (%) 13 Table 2.5 Growth Rate of Exports for Labor-Intensive Goods, 1978-1996 (%) 13 Table 2.6 The World’s Largest Bilateral Merchandise Trade Flows in Some Individual Years (million US dollars) 18 Table 2.7 The Estimated Average Proportion of Outward Processing Trade in Total Trade with China, 1989-2002 (%) 30 Table 2.8 The Estimated Proportion of Outward Processing Trade in Hong Kong – China Total Trade, 1989-2002 (%) 36 Table 2.9 An Intensity of Trade Analysis for Hong Kong-China Trade, 1980-2002 46 Table 3.1 Shares of Main Provinces and Municipalities of China in Realized Foreign Direct Investment from Hong Kong, 1986-2001 (US$1,000) 81 Table 3.2 FDI Flows, Total Exports, and Exports by Foreign Invested Enterprises (FIEs) in China, 1986-1999 (millions of US$) 87 Table 3.3 Status of Registered Enterprises with Foreign Capital in China, 1986-2000 90 iv Table 4.1 Shares of Guangdong & Shanghai in China’s GDP and Exports, 1978-2002 (%) 98 Table 4.2 Hong Kong's Imports from the Mainland Involving Outward Processing, 1989-2002 (US$ million) 101 v LIST OF FIGURES Figure 2.1 Comparison of Total Trade Value with Outward Processing Trade Value for Hong Kong – China Trade, 1985-2002 37 Figure 2.2 Unadjusted (Grubel-Lloyd) Index and Adjusted (Aquino) Index for Hong Kong – China Intra-industry Trade in Domestic Outward Processing Trade, 1985-2002 41 Figure 2.3 Unadjusted (Grubel-Lloyd) Index and Adjusted (Aquino) Index for Hong Kong – China Intra-industry Trade in Re-export Outward Processing Trade, 1985-2002 43 Figure 2.4 Intensity of Trade Index for Hong Kong – China Trade, 1980-2002 48 Figure 2.5 Trade Complementarity Index for Hong Kong – China Trade, 1980-2002 49 Figure 2.6 Country Bias (trade resistance) Index for Hong Kong – China Trade, 1980-2001 50 Figure 3.1 Total Investment in Fixed Assets in China by Source of Funds (1981-2001) 57 Figure 3.2 Foreign Direct Investment in China by Country/Region, 1979-2001 (percent of total) 62 Figure 3.3 The Share of Hong Kong’s Foreign Investment in China’s Contracted Utilization and Actual Utilization of Foreign Capital (1986-2002) 71 Figure 3.4 The Share of Hong Kong’s Foreign Direct Investment (FDI) in China’s Contracted Utilization and Actual Utilization of Foreign Direct Investment (1986-2002) 71 vi Figure 3.5 Hong Kong’s Contribution to China’s Utilization of Foreign Investment (1986-2002) 74 Figure 3.6 Shares of Realized FDI in Total Investment in Fixed Assets by Regions of China, 1986-2001 83 Figure 3.7 the Proportion of Realized FDI from Hong Kong in Total Realized FDI Utilized by Regions in China, 1986-2001 83 vii SUMMARY China opened its door to the outside in 1978, when it began the process of economic integration into the world economy A series of reforms in areas ranging from foreign trade, foreign investment, taxation and finance, banking, foreign currency and price control, to social welfare and housing, are being implemented Among these, reforms and achievements of trade and foreign investment are remarkable Trade liberalization is a key component of China’s overall economic reform and modernization program So far it has proceeded unilaterally and generated a huge expansion of China’s role in world trade China adopted the policies that can facilitate the exports of labor-intensive products and export-oriented economy Although the regional distribution of China’s exports and imports has diversified around the world, it still relies to certain extent on Hong Kong’s position The revealed comparative advantage index is applied to analyze the composition of commodity for exports and its future changing pattern Inflows of foreign direct investment to China virtually nonexistent before 1979, has poured at an accelerating speed since 1992 However, with more openness and more liberalization, the uneven geographical distribution of foreign investment between the east regions and the inner regions in China would be reinforced A large amount of investment from Hong Kong makes such regional inequality worse Through the investigation on the performance of foreign-invested enterprises, it is proved that foreign-invested enterprises made great contribution to China’s export growth Hong Kong has played a strategic part in the process of connecting China with the outside world China's "Hong Kong connection" has been vital to the success of its export drive Hong Kong’s contribution to the development of China's exports goes viii to the outside world after its accession to the WTO and the changing exporting ways of companies in the hinterland, the re-exporting business of Hong Kong has been influenced seriously Entrepôt trade in Hong Kong has continuously decreased by a big margin The figure from Hong Kong Census and Statistical Department shows that from April 2001 to March 2002, the value of the domestic export of Hong Kong declined by 9.8 percent and that of the re-export also decreased by 9.63 percent The value of total exports was less than that of last year by 9.5 percent In the recent two years, the re-export trade in Hong Kong appeared a trend of being shrunk quickly The offshore trade by Hong Kong companies has rapidly expanded at a very impressive rate During the period of 1997-2000, the annual average growth in the offshore trade reached 10.6 percent Even though the increase in the offshore trade will stimulate the need of Hong Kong as trade service supporter and strengthen its position as regional trade pivot, it also means the decreasing frequency in utilizing the ports of Hong Kong From a long-term point of view, the establishment of international shipping centers in Guangzhou, Shenzhen and Shanghai, the increasing voyage routes along the coastal ports and the enhanced ability of the inner airports to take on international transports will definitely produce a great pressure on Hong Kong’s exports and re-exports The decrease in re-exports, rapid growth in offshore trade and more foreign firms’ direct entering or purchases from the Mainland (with complete trading and retailing right) make Hong Kong’s intermediary role to be critically challenged Due to the fact that the fee charged by the ports along the coastal cities in China is much cheaper than that charged by Hong Kong ports, more and more cargo ships choose the ports of the hinterland as their starting points and destination of shipping The surging charges of re-exports and voyage services in Hong Kong have become a detrimental factor to its 119 port industry According to a statistical study of China’s General Customs, the handling fee for one container ranges from HK$2100 to HK$2800, which is four times that of the normal fee in Shanghai, one half to two times that of Shenzhen, one-third to one half higher than that charged by Singapore, and double that of Kaohsiung in Taiwan The underlying cause is not just the imbalance between supply and demand, but also the high land price, the monopoly power and the existence of market power among the small number of operators in Hong Kong Even if Hong Kong speeds up the construction of infrastructural facilities in the future, re-exporting charges are unlikely to fall That gives China and other places an opportunity to generate effective competition with Hong Kong The infrastructural constructions in Guangzhou ports, Shenzhen Yantian port and Dalian port have been extensively in progress, which would negatively affect the entrepôt trade and the development of the port industry in Hong Kong 5.3 Prospects for China’s Economic Development and Hong Kong’s Role In recent years, Shanghai is becoming a center involving financial service, high-tech industry, information supply and kinds of service-oriented production It indeed boosts of sparklingly new industrial estate, better distribution with extensive aviation linkages and technological capabilities which are important factors for foreign investors With Chinese government’s plan on booming of Yangtze Delta economy in the new century, Shanghai has a reasonable chance to stand for a regional financial hub even an international financial center Whether Hong Kong is complementary or competitive with Shanghai is not very important, Hong Kong’s development in the service industry is actually a good example for Shanghai to consult with during the capital liberalization 120 process Even though the challenges must have been encountered in the deepening reform in financial sector, China has not only gained foreign investment in the sector, but also painful lessons in understanding the problems that would emerge from a too-fast maturing financial sector China is crossing into the era of knowledge-based economies To avoid being left stranded in the information highway, China should expand on its research and development and dedicate more resources to the upgraded technology As a developing country, if China wants to catch up with the rest of the world as fast as it can, it has to move gradually away from it primary goods, low value-added industrial sectors to develop the high value-add and capital-intensive production, and its own technological capabilities Most areas in China are now in the midst of upgrading their economy, catching the chance of accession to the WTO They would definitely facilitate their economic reform and structural transformation Thus, it could be more optimistic in term of equal distribution of income in the future Hong Kong’s investment has begun to move inwards to the northern areas and more other countries capitals are flowing into the interior With the gradual and even spread of investment, the hinterland of China is expected to develop faster in a balanced way, closing up the big income and technology gap with the developed areas in China In the long term, Chinese government ought to institute more appropriate measures to facilitate the development of backland The general conditions of China’s hard environment (such as the general condition and future prospects of various infrastructures) and soft environment (culture, political system, legal and regulatory systems, lab relations and business services etc.) of investment will be improved by the Chinese government to meet the requirement of the WTO and the most problems would be resolved to a level comparable with developed 121 economies in the long term Although there is still a need for attracting the foreign investors, the local officials in most provinces have more realistic expectation and clearly know what they want from foreigners and what they can offer to them The institutional frames of absorbing foreign capital are getting better and better China is a poor, large, developing country Giving it more time and understanding all the factors influenced its reform would get a valid judgment about the whole quality of China’s investment environment For China, WTO membership marks a watershed in its ongoing reform and modernization programme, as the country adapts its legal and regulatory framework of foreign trade and investment and makes it consistent with its WTO commitments For Hong Kong, China's WTO accession would denote another defining moment in the structural transformation of the Hong Kong economy When China has to liberalize the services sector to meet the WTO requirements and the peripheral regions around Hong Kong take on the rapid economic development, it is inevitable that the international functions of Hong Kong will be partly replaced and its intermediary position will be undermined to some extent The service industries of Hong Kong that are expected to be moved out to the Mainland in a large scale in the future would exert a tremendous influence on the long-term development of Hong Kong economy and local welfare, as the manufacturing sector did in the late 80s and early 90s On the one hand, China’s accession to the WTO will benefit the specialists of Hong Kong in obtaining more chances of developing the career in the Mainland On the other hand, the expensive charge and service cost of Hong Kong’s professional services will lower its competitive ability in the competition with other cities of China Although Hong Kong can acquire more opportunities from China’s more liberalizing market, it 122 can not gain more profits but has to face much severer competition from the companies of Europe and North America in such aspects as finance, insurance and telecommunication because Hong Kong companies not have notable advantages in these fields Nevertheless, other kinds of services, for instance, retail trade, tourism, air transportation, accounting and commodities inspection, are Hong Kong’s forte The economy of the Pearl River Delta (PRD) is undergoing a transformation Local service industry that can replace Hong Kong’s service sector in function begins to rise Because of the low cost (including factor and transportation cost), it has played more and more powerful role of replacing the service industry of Hong Kong The economy in PRD has transformed from traditional labor-intensive manufacturing industry to information technology industry The products sales to the hinterland have increased and the amount for exports has decreased, the transportation pattern has changed from port exporting to air transporting And it needs advanced producer services, different from the traditional service provided by Hong Kong As a result, even if the economy in PRD rapidly grows, its need for Hong Kong’s service is still stagnant and the traditional manufacturing in Hong Kong is going on shrinking quickly To promote further development of Hong Kong economy and the economic relationship with the Mainland, China and Hong Kong commenced the consultations on a Closer Economic Partnership Arrangement (CEPA) in January 2002 Agreement on the main parts of CEPA was reached and signed on 29 June 2003 CEPA is the first bilateral Free Trade Agreement (FTA) for both the Chinese Mainland and Hong Kong It abides fully by the WTO's requirements on FTAs The Arrangement is to promote Hong Kong’s products and business service, business environment, and comprehensive advantages, and enhance the diversity of business cooperation between mainland and Hong Kong 123 To be implemented from 1st January 2004, the Arrangement is to ensure that Hong Kong will be "economically interlocked" with the Mainland and that Hong Kong smaller companies will benefit from the opening-up and liberalization on the Mainland beyond China's commitments in its WTO accession With CEPA, 90 percent of Hong Kong domestic exports to the Mainland can enjoy zero tariffs Also, CEPA opens up 18 service industries to Hong Kong companies More important, CEPA provides long-term opportunities for Hong Kong people to establish business or work on the Mainland The immediate benefit of the trade in goods is the saving in tariffs, thus increasing the price competitiveness of Hong Kong's domestic exports of consumer products into the Mainland Domestic exports to the Mainland are expected to increase, while some manufacturing activities in Hong Kong will benefit from CEPA, especially when the product list of zero tariff access is expanded Industries that are more likely to be benefited include fashion, jewellery and high-end watches Most manufacturers in Hong Kong will continue to use the Mainland as their production base However, some of them might consider expanding their existing facilities or setting up new production lines in Hong Kong to take advantage of CEPA A longer-term effect of the zero-tariff agreement is the potential for attracting more high value-added manufacturing activities to be located in Hong Kong Besides, given the zero tariff advantage of Hong Kong's exports to the Mainland, it is hoped that some foreign manufacturers that plan to set up production lines in the region will be attracted instead to Hong Kong The impact of CEPA on the service sector is likely to be greater than that on the manufacturing sector CEPA will bring immense benefits to Hong Kong's service economy This is particularly true when services, accounting for only 34 percent of China's GDP, have become a constraint on the country's economic development Contributing 87 percent to the domestic economy, services are well developed in Hong 124 Kong and will be able to contribute more to the modernization of the Mainland under CEPA Hong Kong services companies can benefit from CEPA in two major ways One is the more effective market entry for Hong Kong SME services companies, through the lowering of asset, capital, turnover and operational requirements The other is to have more opportunities for Hong Kong services professionals to practice on the Mainland Although the immediate benefit of CEPA for industrial employment in Hong Kong may only be moderate, much more future employment opportunities in the service sector will be created across the boundary The overall effect on total employment could be significant CEPA will strengthen Hong Kong's role as an international financial centre for China and the Pearl River Delta (PRD) Under CEPA, the Mainland supports Chinese banks in re-locating their international treasury and foreign exchange trading centers to Hong Kong They are also encouraged to expand their banking business in Hong Kong through acquisition In the process of financial reform on the Mainland, the financial intermediaries in Hong Kong will be fully utilized Given the proximity of Hong Kong to the PRD, CEPA has a special meaning to the closer co-operation of the two places With CEPA, the PRD will continue to grow from strength to strength as the world's manufacturing centre, fully supported by the business services provided by Hong Kong companies Waiving Hong Kong lawyers' residency requirements for operating in the PRD is just an example of the special convenience provided by CEPA to enhance the partnership of the Greater PRD Immediate trade and employment creation is, of course, important to Hong Kong, but the long term effect of CEPA is much more substantial Indeed, the pace of Hong Kong's economic restructuring will accelerate under CEPA While the impact will evolve over time, it is likely to be reflected more in Hong Kong's GNP than in its GDP 125 The opportunities arising from CEPA are not limited to activities within the Hong Kong Special Administrative Region but go much farther into the Mainland Hong Kong is 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Zhejiang Provincial Statistical Bureau Yearbook of China's Foreign Economic Relations and Trade, 2002, Beijing: China Foreign Economic Relations and Trade Publishing House 133 ... very intensive economic relation with Hong Kong are to be probed in Chapter And Chapter goes on to the conclusion and prospects for China’s economic development and linkup with Hong Kong Chapter... imports, and Xw is total world imports Using the data of Hong Kong and the Mainland trade might be less accurate to demonstrate the close economic integration trend than employing the data of Hong Kong. ..CHINA’S INTEGRATION INTO THE WORLD ECONOMY AND IMPACT ON ECONOMIC LINKS WITH HONG KONG LI JUN (B.ARTS, SHANDONG UNIVERSITY) A THESIS SUBMITTED FOR THE DEGREE OF MASTER OF SOCIAL