Understanding the Hong Kong Economy

“Understanding the Global Economy for Non-Finance People” https://artandfinance.net/2016/03/21/understanding-the-global-economy-for-non-finance-people/
“Why Hong Kong is failing to rein in housing prices”
“Hong Kong’s budget won’t fix core problems of dominant cartels and lack of competitiveness”

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Yes, here I am, finally back with a new full vlog. What’s taken so long? The last full video I did, which was on Disney, came out at the begiinng of last year, so, what gives? Well, actually a lot of very good things have happened to Art and Finance in 2017. Stick around to the end of this vlog to learn more of what went on last year and what I’m planning to do this year, 2018. Now, onto the Hong Kong economy!

When you think of a world class city that’s also a center for international business, finance, and even culture, Hong Kong might come to mind. Upon landing in Hong Kong International Airport, you can take a train that takes you straight to the center of town, also known as Central. Pretty convenient. Pretty efficient. Pretty much made for business.

So let’s take a look at how Hong Kong’s economy is structured, how it came to be this way, and the challenges it faces. As usual, I’d first like to disclose that I’m a stock analyst, not an economist, but the scope of my research involves understanding the basics of how an economy functions. So, in this video we’ll just be talking about the basics of the Hong Kong economy. Additionally, the footage I’m using for this vlog on Hong Kong was taken in June of 2016, so it might be a little dated, but not by much, I don’t think. Also, please click the link in the description for all the relevant sources used in this vlog.

Now, let’s start with some background. What we now know as the city-state of Hong Kong is actually a collection of China’s Kowloon peninsula and several islands, including Hong Kong island proper. These territories were ceded from China to the British following several wars throughout the mid- to late-1800s. Check it out, you can take a ferry between Hong Kong island and the Kowloon peninsula.

The British developed their new colony into a trading and financial center, given its proximity to China, Northeast Asia, and Southeast Asia. The city has boasted a developed legal system, based on English common law, and a laissez-faire approach to the economy, which roughly means relatively fewer government regulations when it comes to business and some of the lowest taxes in the world. So, you could imagine that this is a great place to be if you’re a businessperson. In fact, Hong Kong often ranks as one of the freest economies in the world. One ranking of the most business-friendly economies has put Hong Kong on the top for 22 years straight. The fact that the head of Hong Kong’s government is known as the Chief Executive says a lot about the city state’s emphasis on business.

However, Hong Kong was meant to return to Chinese control. The 1984 Sino-British joint declaration promulgated that Hong Kong would be handed over to China in 1997. Since the ’97 handover, the Chinese government has dealt with Hong Kong’s unique political and economic structure under the “one country, two systems” approach, where both territories keep their unique systems for 50 years starting from 1997.

Now that we know a bit about Hong Kong’s history, let’s dive into the nitty gritty of how this city operates.

Here we are at the wealthy mid-levels, located near Central. I imagine it’s called the mid-levels because it’s on a hillside. The world’s longest outdoor escalator, the Central-Mid Levels escalator, is also here. Walking around this area, we might wonder how such a wealthy city like Hong Kong, with very few natural resources, can thrive for decades. So, let’s find out how it succeeded.

Of course, Hong Kong’s role as a port helps, with goods and money flowing in because of trade. And obviously, the pro-business, laissez-faire economy also doesn’t hurt. Let’s take a look at some of the key features of Hong Kong’s economy that may have had a role in the city’s success.

The first characteristic is, as I’ve mentioned before, Hong Kong’s low, low tax rate. The standard income tax rate, both personal and corporate, hovers around 15%. And the city-state doesn’t even have a tax on retail sales or capital gains. But remember that a government gets its money from taxes. So, where does the Hong Kong government get most of its revenues?

The answer is land. A large amount of government revenue comes from land. In fact, in contrast to other countries where private citizens can own land, the government technically owns ALL the land available in Hong Kong. What the government does with all this land is lease developable land to real estate developers via auction. Hence, low tax rates in Hong Kong because the government gets much of its revenue from land lease.

Another important aspect is Hong Kong’s currency. The Hong Kong dollar is pegged to the US dollar, with Hong Kong’s central bank, known as the HKMA, buying and selling Hong Kong dollars until it reaches the target exchange rate with the US dollar.

Why would the HKMA peg the Hong Kong dollar to the US dollar? One reason is stability for foreign investors. If you are a businessperson bringing your money into and out of Hong Kong, you can rest assured that Hong Kong’s currency is not going to radically change in value against the US dollar, which is used in many international business transactions. The downside of a pegged currency is that Hong Kong interest rates tend to move in tandem with US interest rates, which may not necessarily be a good thing for Hong Kong.

If you want to understand how interest rates and foreign currency work, I did a writeup a while back called “Understanding the Global Economy for Non-Finance People” which you can check out through the link in the description.

Lastly, Hong Kong has fewer business regulations compared to other countries. On one hand, fewer business regulations are good, since fewer restrictions means it’s easier to start and run a business. On the other hand, there are other important social concerns that might require more business regulation – think about putting up a factory versus environmental concerns, for example. So there are pros and cons to regulation, and the government has a delicate balancing act to do in this area.

One example of fewer regulations in Hong Kong is that companies can hire relatively cheaper foreign labor, making Hong Kong businesses relatively more competitive. But you can imagine the downside to this.

So Hong Kong had these unique, laissez-faire features of its economy that helped money flow in and business flourish. In that sense, Hong Kong’s economic development was different than those of other East Asian countries, where the government had a larger role to play. However, that doesn’t mean that the Hong Kong government didn’t do anything. The government played an active role in public housing, infrastructure, and land reclamation. This helped nurture Hong Kong’s industrialization in the mid-20th century, via a vibrant manufacturing sector, raising the standard of living for the average citizen. During this period, Hong Kong excelled in textile and garment manufacturing. It was also the number one toy manufacturer in the world.

With economic development came cultural development. For example, Hong Kong cinema is famous around the world, from the more artistic, to the more slapstick, and sometimes even inspiring Hollywood remakes. The food’s awesome too. Who doesn’t love Chinese dumplings, also known dimsum? This is Tim Ho Wan, famously known as the cheapest restaurant in the world with a Micheline star.

Now that we’ve looked at Hong Kong’s successes, let’s look at the challenges it faces today.

A major paradigm shift within Hong Kong began when China opened itself up to international trade starting in 1978. Manufacturing jobs were relocated from Hong Kong to mainland China to take advantage of cheaper wage rates. The Hong Kong economy itself then rebalanced away from manufacturing and more toward services – both commercial and financial.

So what are these services? Financial services, which make up about 18% of the economy, include activities such as banking. Not a surprise given the flow of money to Hong Kong due to its role as a business and financial center. But what about commercial services? This is where things get interesting.

Given Hong Kong’s proximity and historical ties with China, it only makes sense that China has in recent times been a major consumer of Hong Kong’s services. For example, Hong Kong’s retail sector has benefitted from increasing wealth in China, with luxury goods in Hong Kong being 40% cheaper than those in China. That’s all well and good when the Chinese economy grows rapidly, as it had been during the 2000’s. However, with China slowing down in recent years, Hong Kong commercial services, such as tourism and retail, and also its financial services, have been hit as well. It also doesn’t help that other countries in recent years have decreased visa restrictions on mainland Chinese to get their tourism money, or that China itself as lowered the taxes on imported goods, bringing consumption back within its borders.

Furthermore, there are two interrelated structural issues that the Hong Kong economy faces. These issues actually stem from the unique characteristics of the economy we learned about earlier.

The first has to do with property. Remember that the Hong Kong government generates a large portion of its revenue from land auctions, where land is leased to developers. What’s happened recently, however, is that Mainland Chinese demand for Hong Kong property has boomed. This has caused developers to bid higher and higher at land auctions, which in turn drastically increases housing prices, to the point where in one series of surveys, Hong Kong has had the least affordable housing in the world for seven years in a row.

And unfortunately, local wage growth has not kept up with property prices. You’d have to be rather wealthy to afford a decent place in Hong Kong.

This brings us to the next issue with Hong Kong: increasing inequality. Despite Hong Kong’s relatively low unemployment rate, inequality has continually climbed. In 2017, Hong Kong’s Gini coefficient – a measure of inequality that ranges from 0 (meaning total equality) to 1 (meaning total inequality) – was at a record 0.539, the highest it’s ever been for Hong Kong since data became available in the 1970’s. In fact, Hong Kong’s Gini coefficient is currently the largest in Asia.

One main reason for this, as we’ve discussed earlier, is surging property prices. In fact, since housing prices are increasing, first-time buyers have to take out more and more mortgages, which are basically loans to buy property. What makes this even worse is the Hong Kong dollar being pegged to the US dollar, which I talked about earlier. If US interest rates increase, so might Hong Kong interest rates. That means the interest rates that buyers will pay on mortgages will increase, meaning that they will have less money to spend on other things in Hong Kong and support the economy. Not a good sign.

And let’s not even get started on the less fortunate, some of whom basically live in cages because it’s just so difficult to afford housing.

Another problem: it doesn’t help that decently-paying manufacturing jobs have moved elsewhere, while local jobs have bifurcated into extremely high-paying and low-paying jobs. Hmm. This story sounds familiar.

Lastly, some criticize the concentration of big business into the hands of a few players in Hong Kong. The Hong Kong government’s hands-off approach to business may have inadvertently led to a handful of large, entrenched companies, stifling competition and increasing the concentration of wealth. Foreign firms have reportedly struggled to enter Hong Kong to compete with these incumbents, for example. As one economist noted, these businesses’ profits are shielded from competition on the one hand, while on the other, labor cannot easily organize, exacerbating inequality.

Given these problems, the next question is, what can the government do about them, or what is it doing? Well, given the government’s historical championing of free markets, any heavy regulation is rather limited. But, the government has done a few things.

Regarding the ridiculous property prices, the government’s two main measures to cool real estate so far are 1) a 15% tax on second home purchases, known as a stamp duty, to discourage speculators, and 2) higher restrictions on mortgages, which are meant to favor first time buyers. Yet prices have continued to rise. Why is that?

Depends on who you talk to, but some criticize the choice of public policy. I’ll link to this article from the South China Morning Post if you want to get an idea of what such criticisms are.

Regarding a solution the second issue, the bifurcation of wages into low- and high-end salaries, well, current Chief Executive Carrie Lam has stated her desire to transform Hong Kong into a “high, value-added and diversified economy.” I interpret that statement as a goal to create industries such as a tech industry to give the Hong Kong middle class more employment opportunities and a better standard of living. However…

Here is an article, written by Peter Guy at the South China Morning Post, that clearly delineates the difficulties in changing the Hong Kong economy for the better. Three key points from the article:

  • The traditionally hands-off Hong Kong government would have to take more direct risks in funding startups.
  • Much of Hong Kong’s big business is involved in property development, so what’s their incentive to invest in research and development?
  • Even if Hong Kong develops new technology, there is no large domestic tech sector to harness any patents to give Hong Kong an edge in this sector.

Finally, what about high inequality? Well, we talked a bit about this when addressing the housing issue. Other than that, one popular answer to high inequality is to have a progressive tax regime, where higher earners have to pay a heftier income tax. The thing is, a progressive tax regime already exists in Hong Kong, with the top 5% of taxpayers reportedly accounting for more than 60% of the government’s take from incomes. Despite this, some effective redistribution and an equalizing of society has not been the outcome.

One reason for this might be the problem of a narrow tax base, where high earners who are also highly taxed will find legal ways to avoid taxes, so perhaps the government isn’t getting as much tax revenue as it would like. One solution for more tax revenue is a goods and services tax, but this is politically unpopular.

By the way, there’s also the looming issue of Hong Kong’s reintegration into China, with quite a number of Hong Kongers opposed to further reintegration with the Mainland.

So, the situation is tough. Of course, I don’t know the answers to all these problems, but I imagine someone or a group of people, or maybe even a majority of voters, can make the tough but ultimately long–term positive decisions for the Hong Kong economy. Hong Kong has made some very smart moves in the past, so I wouldn’t be surprised if it continues to do so in the future.


WAIT! So, a little bit of what went on with Art and Finance last year. The good news is that I’ve found a revenue stream! I’ve had two successful fine art exhibits in Manila. So I’m very happy to let you guys know that it looks like Art and Finance can work as a business!

Of course, I’ve had to do a little pivoting as well. I’ve launched a sub-brand called First World Manila, since I’m currently located in Manila, and I’m also relaunching this vlog and my web manga Ilusion, under new formats.

What are these new formats? Well I can’t say too much for now except that you can expect more frequent turnover for both, and live recordings for the vlog. Expect the changes to launch sometime this February.

In the meantime, thank you all for your support! And if you haven’t already –please do extend support! – Like or follow, or even buy some merchandise – links in the description! See you soon!

Ramon Rodrigo Cuenca, CFA
Equities Analyst
Art and Finance

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