All Commentary
Friday, May 1, 1964

Hong Kong: Nothing but Common Sense


Reprinted by permission from The Morgan Guaranty Survey, November, 1963.

With no minerals, no oil, no agriculture, and not even an adequate water supply, Hong Kong is bursting with activity and growth.

How come? Nothing more than a common-sense faith in a free market unfettered by government intervention! An economic bright spot on the face of the earth where people can freely pro­duce and exchange!

What will happen now that these people are prosperous? Will they continue to buck the socialistic tide of the twentieth century?—Or imitate the U. S. A.?

Perched at a tiny crack in Red China’s bamboo curtain is a bus­tling, prosperous enclave of free enterprise. This is the British Crown Colony of Hong Kong, a “crossroads of the Far East” to travelogue audiences and a center of trade and finance to interna­tionally-minded businessmen.

Location early made Hong Kong a main channel for trade between the Western world and China. A tradition of holding governmental regulation to a minimum has made it a preferred haven for capital, a lively center of financial dealing, and an active and versatile for­eign-exchange market. Over the past decade or so, the Colony has added important new ingredients to its economic mix. A busy com­plex of light industry has sprung up, with products running a gam­ut from textiles to transistor ra­dios. Tourism has taken on a new dimension, aided by regular shore-leave visitations by personnel of the United States Asian fleet. And, spurred in part by the new di­versification, there has been a major building boom.

With the new mix has come a marked spurt in economic growth. Hong Kong does not tot up an estimate of gross national prod­uct, but there are ample indica­tions that things are going well. Foreign trade has risen sharply, with both imports and exports up about 34 per cent in the past three years. The Colony’s 398 square miles (not much more than the area of New York City) are dot­ted with new construction: hotels, high-rise apartments, schools, fac­tories. And the economy has man­aged to shelter a million refugees from Communist China since 1949.

All this has happened in a laissez faire environment that contrasts sharply with the gov­ernment – action formula with which most nations of the world are pursuing economic growth. Hong Kong’s foreign trade is al­most entirely free. Import duties—imposed to collect revenue, not to restrict the movement of goods—apply to only five groups of products: liquor, tobacco, hydro­carbon oils, table waters, and methyl alcohol. Except for ster­ling, which is restricted under British Commonwealth rules, cur­rencies may be transferred read­ily; there are both a “free” and an “official” market. In the free market entry and exit of capital are unrestricted; establishment of new businesses is not inhibit­ed; foreign investors may take out profits and capital at will. The corporate tax rate on profits earned within the Colony is 121/2 per cent; profits earned overseas are tax-free even when brought home.

To accomplish its special brand of postwar economic wonder, Hong Kong turned adversity—the influx of refugees from Red China—into an advantage. Dur­ing the two years 1949-50, the refugee tide added one person to the population for every two al­ready there—an inflow of 750,000. To compound the problem, Hong Kong’s traditional business of serving as a trade vestibule to and from mainland China was soon to be reduced severely. The free-world countries put an em­bargo on shipments of strategic goods to the mainland shortly after the Chinese Communists entered the Korean War.

But the surge of migrants brought with it the makings of Hong Kong’s new economic era. Some of those who came were ex­perienced industrialists. Some managed to bring capital from the mainland. Some had ordered machinery for delivery to Shang­hai and had it diverted to Hong Kong. Many were skilled workers.

Applying their capital, equip­ment, and know-how, the refugees set up a variety of new industries that today have Hong Kong hum­ming. There were some 2,500 fac­tories in operation in 1954; by the end of 1962, there were 7,300.

The textile industry is by far the largest. Last year it employed 42 per cent of the labor force and produced more than half (about $300 million) of Hong Kong’s manufactured exports. Other lines include plastics, transistor radios, air conditioners, electric fans, plywood, carpets, stainless steel cutlery, clocks, cameras, and bi­noculars. Machine building—start­ed to supply the Colony’s own manufacturing—has expanded in­to a substantial export business. Hong Kong machinery is now be­ing sold in 70 countries.

Colony entrepreneurs have shown considerable ingenuity in turning local circumstance into profitable business operations. Airport modernization—begun in 1956 to accommodate the needs of the new international jet traf­fic—led to the development of an aircraft maintenance industry, which now overhauls airframes and engines for both civilian and military planes based in 38 coun­tries. The floor of Hong Kong’s magnificent harbor provided raw material for a new industry. En­terprising salvagers brought up ships sunk during the war, tore them up, rolled the scrap into steel reinforcing bars. Ship breaking became an important activity: ships are now imported for demo­lition, and last year enough steel rods and bars were rolled to sup­ply a large part of the needs for local construction and furnish some for export.

Economic growth has spurred a widespread building boom. Sat­ellite towns, which include indus­trial and commercial as well as residential areas, have sprung up in the New Territories, a 365­square-mile block of mainland and islands that was attached to the Colony under a 99-year lease agreement signed by China and Great Britain in 1898. In the cap­ital city of Victoria, on Hong Kong Island, the commercial dis­trict is being redeveloped, with plans already drawn for improved port facilities and new public and commercial buildings. The new airport terminal, opened last year on the mainland, is to be expand­ed. A terminal for ocean-going passenger ships is on the draw­ing board. And a dozen hotels completed last year and under construction this year will more than double the Colony’s room count.

The pace of building has neces­sitated a program of land rec­lamation. In crowded Hong Kong, construction sites are likely to be made rather than found. Hills are leveled to provide buildable locations. The earth sliced from the hills is dumped in the harbors to create other sites from the sea.

Funds for Growth

The heady pace of Hong Kong’s economic development has brought growth in demand for capital. On the whole, the demand has been well satisfied by the Colony’s banking system. The build-up in manufacturing has been financed principally by the banks, which have advanced working capital, made medium- and longer-term loans, and also provided some per­manent investment. The banks have stretched themselves over the whole maturity spectrum, and even into equity investment, be­cause a proper capital market has yet to develop. Individual inves­tors in Hong Kong have a marked preference for liquidity; by and large, they have poured their funds into bank deposits.

All told, there are more than 90 “banks” in Hong Kong, includ­ing branches of eight mainland banks, which appear to compete with each other in fine disregard of socialist doctrine. The total is swollen by a variety of bullion dealers, sales finance companies, and security houses that would not be classed as banks by U.S. definition. Even so, the scope of conventional banking activity is impressive, given the size of the Colony. Hong Kong does not com­pile comprehensive banking sta­tistics; but, at the end of 1961, available figures showed that 59 of the largest banks in the Colony had total deposits equivalent to almost $600 million—44 per cent in demand deposits, 36 per cent in time accounts, 20 per cent in savings deposits. All three deposit categories had shown sharp and steady increases. From 1955 to 1961, demand deposits were up 73 per cent, time money jumped more than eightfold, and savings accounts were up almost fivefold.

Deposit growth did not come by accident. The major Hong Kong banks have rapidly expanded their branch systems, now are operat­ing a total of almost 225 offices, or approximately one for every 15,500 of population. This com­pares with one banking office per 11,600 residents in the five bor­oughs of New York City (or one for 7,900 if savings banks and sav­ings and loan associations are in­cluded). The banks have bid ag­gressively for deposits—interest rates on demand money run as high as 2 per cent, personal sav­ings bring 3 per cent, time money rates generally run from 5 per cent.

This busy banking scene has not been entirely trouble-free. In mid-1961, one of the largest lo­cally-owned banks suffered a li­quidity crisis and had to be helped with a loan from other banks. The trouble had stemmed from an overly high proportion of long-­term loans and illiquid invest­ments. The incident served as a warning; as a direct consequence, an official from the Bank of Eng­land was invited to study the Hong Kong banking system and to make recommendations for re­form.

The survey led to a new bank­ing code that goes into effect next year, which for the first time will place Hong Kong banks under a measure of regulatory control. In general, the banks will be required to maintain a liquid asset ratio of 25 per cent in relation to their liabilities, and over the years will have to build a cushion of re­serves. In addition, a variety of lending limits have been estab­lished, and henceforth banks will have to keep their books open for examination by a banking com­missioner.

The new regulations are de­signed solely for depositor protec­tion. There is nothing in the code to suggest that the Hong Kong government plans to use monetary policy as a lever for controlling the economy. Most Hong Kong bankers seem to feel that, while the banking controls are a de­parture from the tradition of laissez faire, the introduction of some gentle discipline will in time enhance Hong Kong’s position as a financial center in the Far East.

But if the Colony’s role as a money center is to broaden sig­nificantly, its capital market will have to be developed. Despite an ample supply of funds, there has been no meaningful flow of equity offerings to provide the making of a public market. Nor is Hong Kong an active market for for­eign issues; local opportunities have been great, and, with profits taxed at only 121/2 per cent, it has been hard to find a richer net re­turn overseas.

Meanwhile, the flow of outside funds is picking up. It is esti­mated that some $500 million a year comes in seeking haven—mostly sent by Chinese living in Southeast Asia. Moreover, the rising pace of industry and tour­ism is starting to stimulate direct investment from overseas—espe­cially from the United States. The Commerce Department estimates that total American investment in the Colony at the end of 1962 was $70 million. Nearly 300 U.S. companies are represented there. The principal external investor in Hong Kong, of course, is the United Kingdom. Japan, too, has been increasing its interest in re­cent years.

Balance of Payments No Problem in Hong Kong

Hong Kong does not keep over­all data on its balance of pay­ments. But bankers in the Colony are convinced that its interna­tional position is healthy, if only because of the strength and sta­bility of the Hong Kong dollar in the rough and tumble of the open market. Today, as for more than a decade, the local unit trades close to its parity of 17.5 U.S. cents (HK$5.7 = U.S.$1).

The Colony’s balance on mer­chandise trade is chronically ad­verse. The value of imports, $1.2 billion last year, runs about one-third more than export earnings. The Colony has to buy most of its goods abroad. The population, es­timated last year at 3.5 million (98 per cent Chinese), is not large enough to support a full line of domestic manufactures. Nor does the tiny territory possess much in the way of industrial raw ma­terials; most primary products—e.g., cotton, metals—are imported. With workable land scarce, some 80 per cent of the food supply also is brought in from outside.

Imports of these essentials have mounted at an average annual rate of almost 10 per cent for the past four years. The principal supplier is mainland China, which—although itself a big importer of food—sells Hong Kong a large part of the latter’s daily diet. In recent years the Red Chinese have supplied nearly one-fifth of the Colony’s imports of all kinds. The next largest supplier is Japan; the United States and United Kingdom contend for third place.

It is estimated that Hong Kong pays for one-third of its imports with proceeds from “invisible” transactions. Much of this income arises from commercial services—chiefly financing and insuring trade. Recently tourism has also developed into an important earner of foreign exchange. Travelers come both for shopping and for sightseeing. The impressive bar­gains and service offered by Hong Kong tailors and dressmakers, along with the luxury and atten­tiveness lavished by the Colony’s hotels, have helped make a visit there a high spot of most Far Eastern tours and cruises. Two years ago, 221,000 tourists left behind some $120 million; all told, tourism is the Colony’s second largest earner of foreign ex­change.

Exports have not quite kept pace with imports in their per­centage growth: foreign sales of all goods—those transshipped and those manufactured—rose nearly 34 per cent in the three years 1959-62 while imports registered a 35 per cent increase. The ex­port gain has been almost entirely in goods made in Hong Kong. Trade of the passing-through variety, once the Colony’s main reliance, has held to a narrow range around the equivalent of $180 million, while exports of lo­cal manufacture have grown from$400 million in 1959 to $582 mil­lion last year. With imports grow­ing somewhat faster, the trade deficit has widened from $293 mil­lion in 1959 to $400 million last year.

Thus Hong Kong must continue to increase its exports if the total economy, so dependent on imports, is to keep growing. Mindful of this, business leaders in the Col­ony are expressing concern over what they believe to be serious faults in both the structure and the style of the export trade. Chiefly, they are troubled by the heavy dependence on markets in the U.S. and U.K., which together buy nearly half of Hong Kong’s manufactured exports.

In the United States, which last year took 26 per cent of the total, textiles encounter quanti­tative barriers. Early last year, under an agreement then in force, the U.S. government asked Hong Kong to exercise “restraint” in exporting several categories of textiles. Since then, a five-year agreement regulating world trade in cotton textiles has been con­cluded by nineteen countries, in­cluding the U.S. and Hong Kong. It reaffirms the right of import­ing countries threatened with “market disruption” to call for restraint by exporters. The ar­rangement went into effect a year ago October, and the U.S. again called for restraint. This action has had the effect of putting ceil­ings on Hong Kong sales of some 30 categories of textile products to the United States.

The dominant position of tex­tiles in the product list is viewed as a liability in itself, since most customer nations practice some degree of protection against tex­tile imports. But up to now, at least, textiles have been a profit­able enough line to make individ­ual entrepreneurs reluctant to risk shifting their capital to less tested ventures, even though the need to build a more diversified manufacturing base is generally acknowledged in the Colony.

Great Britain, which grants fa­vorable rates of duty to Hong Kong goods under the Common­wealth preference system, last year took 22 per cent of the Colony’s manufactured exports. Worry about what would happen to this trade if the U.K. were to join the European Common Mar­ket was not put to rest by the break off of the Brussels negotia­tions early in 1963. Even apart from Common Market jitters, there is fear that Britain’s declin­ing benefit from Commonwealth markets may lead eventually to abolition of preference.

What to do about such disturb­ing possibilities was the subject of a study published this year by an unofficial group called the Hong Kong Working Party on the European Common Market. Busi­ness, labor, press, the colonial government, and the governments of Britain and four of the Com­mon Market countries were repre­sented. The Working Party re­viewed steps Hong Kong might take to boost its sales in the total European market.

The group recommended that Hong Kong manufacturers study the ways of European buyers more closely, also that they try to anticipate restrictions likely to be placed on their goods. Quotas are more dreaded, apparently, than are tariffs at any present or proposed level in the Common Market. Interestingly, the Work­ing Party proposed that Hong Kong eventually might consider requesting an association with the European Economic Community. Meanwhile, it recommended that the Colony publicize its potential usefulness to the industrialized European countries, emphasizing the possibilities of trade with mainland China.

Finding Fault

With considerable candor, the panel also turned its attention to another threat to exports—the shortsighted trading practices of some Hong Kong producers. For instance, the report criticized the tendency of some manufacturers to flood foreign markets. It also mentioned the penchant for copy­ing successful products.

Closely allied to comments like these is the realization that the franchise of Hong Kong mer­chandise has been hurt in world markets by shoddy goods poured into export channels and by obvi­ous attempts to deceive foreign consumers with trade names close­ly resembling familiar brands (e.g., one obscure company in the Colony has exported a “Coalgate” toothpaste).

Sentiment in favor of curbing such injurious practices is grow­ing in the business community. The Federation of Hong Kong Industries, long interested in im­proving the quality of exports, has begun testing textiles for standards of acceptability. The application of moral suasion is likely to grow more vigorous with increasing awareness that depend­able overseas markets can be cul­tivated only on a basis of repeat orders and satisfied customers.

To push exports, the govern­ment has been dispatching trade-promotion teams abroad. Under this program, commercial mis­sionaries have sought larger pur­chases from the rich Common Market countries—which now take only 7 per cent of Hong Kong’s exports—and also have been can­vassing nations in Africa and the Middle East that can usefully im­port a wide range of low-priced consumer goods.

Long-term improvement in ex­ports probably will require, in ad­dition to broadened outlets, great­er diversification of products. Hong Kong has not the capital, technical proficiency, land, nor economic base on which to build heavy or complicated industries. But it does have a fast-growing work force in its predominantly young population. The best bet, consequently, appears to be fur­ther expansion of light industries which utilize labor intensively.

Should Government Be Drafted?

The knottiness of the problems involved in trade expansion, plus an uneasy feeling that the “image” of Hong Kong industry needs touching up, has prompted some businessmen in the Colony to urge that government take a stronger hand in the economy. The advo­cates of such a course seem to envisage an arrangement in which officials would help lay out a sched­ule for orderly diversification of output and a program of quality control.

Intervention of this type would be a drastic departure from the traditional attitude of the Colony’s government where business is in­volved. In a different area, however, the government already has made a significant departure from the past. This was in dealing with the social problems created by the refugee influx which started in 1949. The problems were severe. For every immigrant who came with means, many others came with nothing. They squatted wher­ever they could find a foothold. On the hills rising from Victoria, and around the peninsula city of Kowloon, they built shacks of tin, wood, cardboard, and rags. In places they were jammed as tight as 2,000 to the acre, without sani­tation or piped water.

At first reluctant to depart from its accustomed hands-off policy, the colonial government finally assumed what it was frank to call the “strange new role of financier, contractor and landlord.” After fires in 1953 and 1954 had destroyed the shacks of some 75,000 squatters, the government moved in, cleared and leveled the burnt-out sites, and began erect­ing apartment buildings six and seven stories high, each of which housed approximately 2,000 per­sons at low rentals.

By the end of last year, about half a million people had been resettled in such developments. Perhaps an equal number are still without real housing, but the gov­ernment expects to get enough units built to accommodate them within another five years. Official­ly, the border has been sealed against further immigration, be­cause Hong Kong feels it has reached the limit of its absorptive capacity. Illegal entrants are sent back if apprehended; even so, last year net immigration is believed to have amounted to more than 200,000.

Having taken the plunge in pub­lic housing, the government has deepened its involvement in other activities of the social-benefit type, notably education and pro­grams for health and medical care. It also has undertaken to do some­thing about the chronic problem of water supply, which is now so acute that taps can be turned on only every fourth day and some industries using large quantities of water have had to curtail oper­ations. A ten-year project for building dams, reservoirs, and tunnels was begun in 1960.

The venture into public works has been financed almost entirely from current revenues, which were pushed from the equivalent of $51 million in fiscal 1951 to $186 million in 1962 with no sig­nificant increase in tax rates. An important element in the growth in revenues has been income from the government’s land monopoly (it all belongs to the Crown, and leases are auctioned—at prices that have soared in recent years).

There has been a budget sur­plus in all but one of the past ten years, and total public debt was equivalent to only about $16 mil­lion at the end of fiscal 1962. Some help in meeting the heavy expense of refugee care during the past dozen years has come from outside loans and contribu­tions: about $18 million from the U.K. since 1945; some $50 million from the U.S., mostly in surplus foods; and gifts of undetermined amount from private relief organ­izations.

The Red Shadow

The bustling day-to-day pace of business and the talented mer­chandising of luxury give anxiety little chance to show through in Hong Kong, but the shadow of the red giant to the north flits rest­lessly over any contemplation of the Colony’s future. Peking thus far has carefully avoided striking anything like a menacing pose—in fact, it is more inclined to play the good-neighbor role. For ex­ample, it regularly makes one of its reservoirs available to water-short Hong Kong. The communists have sound reasons to avoid fric­tion. The Colony’s facilities are no less useful to them than to the free world. The Chinese value the hard currency they earn from ex­ports to the Colony. They find welcome the food packages and money sent by Chinese in Hong Kong to relatives north of the border. Also, any show of undue abrasiveness toward a British colony would cast Red China in a hostile confrontation of the one major Western power that recog­nizes the Peking government.

For the long, long pull, Hong Kong’s future is clouded by ter­ritorial uncertainties. Great Brit­ain has outright ownership of less than 10 per cent of the Colony’s area—the island of Hong Kong and the Kowloon peninsula at the tip of the mainland. The lease granted on the rest, comprising the New Territories where the satellite towns are clustered, is due to expire in 1997.

A deadline 33 years away, how­ever, seems comfortably remote. It certainly is not a noticeable damper on the optimism that charges Hong Kong’s day-to-day atmosphere. As time runs on, un­less some prior agreement is reached for extension or other settlement, there probably will be an intensification of the present reluctance to enter into long-term commitments, especially where the New Territories are concerned. But, for the practical people of Hong Kong, accustomed as they are to playing it cool and keeping mobile, 1997 right now is a prob­lem that will have to wait its turn.