Hong Kong is a window to the world through which a life-giving monetary wind blows in both directions, invigorating both the Chinese and global economies
As BBC commentator notes, Western companies invest heavily in China: they assemble phones, sew clothes. And China actively invests in the West: builds power plants, roads and bridges, buys companies and banks. The sums run into hundreds of billions of dollars a year, and most of this money passes through Hong Kong: nearly 60% of China's outward direct investment and more than 70% of attracted capital.
But 20 years after returning to Beijing's rule, clouds are gathering over the former British territory: China is tightening its embrace on autonomy, cultivating competitors for it, and showing force by pulling up tanks to intimidate those dissatisfied with this rapprochement.
China's window to the world threatens to slam shut. This risks problems not only for the world's most populous country but also for the entire global economy. Why is Hong Kong vitally important to China exactly in its current form?
"One Country, Two Systems"
Having returned Hong Kong at the end of the last century, China did not reshape the island's life according to communist patterns and left everything as it was, following the precepts of the father of China's economic miracle, Deng Xiaoping. Hong Kong has different laws, political system, passports, and even language. The judicial system is independent and modeled on the English one. Residents of the autonomy retained freedom of speech, religion, and assembly.
Moreover, Hong Kong is a separate and equal member of the World Trade Organization, with its own currency, trade policy, and financial regulation.
Thanks to this, Hong Kong, like a gateway, connects two radically opposite political systems – communist China and democratic West. It allows them to trade with each other and invest in each other, because it lives by rules that ensure the safety of money, competition, and protection from arbitrariness better than China's Politburo and People's Court.
This is enough for Hong Kong to be the third global financial capital after New York and London and for a quarter of a century to be annually recognized as the freest economy in the world.
China ranks only 100th out of 180 in the Heritage Foundation's Economic Freedom Index, two spots below Russia. Hong Kong's traditional first place has long been contested by Singapore, and in recent years the gap between them has narrowed to a minimum.
"Without a strong and independent judicial system, Hong Kong will lose its unique advantages that made it a financial capital. There are many cities in Asia with low taxes and minimal barriers to investment," warns Heritage Foundation expert Terry Miller. "And if the situation with investor and property protection worsens, international business will start leaving Hong Kong. This will undermine its economy and deprive China of a unique financial bridge to the West."
Second Front in the War with the US
And this is already happening: Hong Kong's economy is suffering from the trade war launched by President Donald Trump in an attempt to reduce the US trade deficit with China. The deficit has only grown, and the end of the war is not in sight.
Hong Kong is not directly involved in this confrontation, as the US treats it as a separate economic partner from China. Besides Hong Kong's independent WTO membership, special relations are also enshrined in a special US law that Congress approved back in 1992 – five years before the return of the British territory to China.
Therefore, Trump's anti-China tariffs do not apply to Hong Kong. And not only tariffs, but also other restrictions: on capital and technology transfers, for example. However, it still suffers from the war. The flow of money through Hong Kong is shrinking: Western companies are moving business from China to other countries and holding back investments, while the Chinese have less free capital due to economic slowdown and reduced lending.
And if Chinese tanks roll through the protest-hit streets of one of the world's most densely populated cities, Hong Kong could become a second front in the war with the US. A bill has long been pending in Congress that would strip the autonomy of all trade and economic privileges. Suppression of freedoms in Hong Kong would sharply increase its chances of being passed. And it would also deprive Trump of the opportunity to reduce already imposed tariffs, from which not only China but also the US suffers: appeasing tyrants with trade concessions is problematic for a country claiming to be the leader of the free world.
This is bad news for the global economy. The trade conflict has already undermined it, and the longer it continues, the more it constrains wealth growth and poverty reduction in the world.
Can China Survive Without Hong Kong?
Hong Kong is having a hard time even without wars. Once the world's largest container port, it first lost ground to Shanghai after China's WTO accession, and now has slipped to seventh place. China's economy is growing, and Hong Kong's share in it is shrinking: at the time of its return in the late 1990s, it exceeded a quarter of China's GDP; now it is only about 3%.
And the population constantly rebels, dissatisfied with the curtailment of freedoms. Protests further undermine the economy. They scare off tourists and property buyers, and companies, under pressure from authorities, try to curb employees' political activity, leading to strikes and layoffs.
If Hong Kong brings less benefit and more headaches, and relations with the US are already damaged, might China decide to seize the moment and eliminate the problem once and for all?
To do this, it will be necessary to violate an international treaty. When transferring the territory, China pledged to preserve all the freedoms of Hong Kong for half a century. Only 20 years have passed, and Beijing has never shown any desire to speed up this process. Moreover, at the last congress, Chairman Xi Jinping praised the principle of "one country, two systems," which many perceived as a hint of readiness to maintain autonomy even after 2047.
The main function of Hong Kong – as a financial center, a transit point for capital – is vital for the Chinese economy, believes the head of the local stock exchange, Charles Li. "In the last 20-30 years, China attracted capital. But if we look to the future, big changes are coming in the next 20 years. Now China itself has enough capital, and its fast and reliable placement is becoming an increasingly pressing issue," Li believes.
The Hong Kong Stock Exchange, one of the five largest in the world, is gradually losing ground to the Shanghai Stock Exchange, but remains the main venue for attracting foreign equity capital for Chinese companies. Last year, they sold shares worth $35 billion in Hong Kong – one and a half times more than on the mainland Chinese exchanges. And although the Chinese giant Alibaba chose New York for its initial public offering five years ago, it plans to conduct a secondary home sale of its shares worth $20 billion on the Hong Kong Stock Exchange, not Shanghai.
Having a Western financial center in a communist country is beneficial. There, you can attract more money at a lower cost, since risks are lower due to regulation and the judicial system. And there are plenty of professionals from around the world who can more easily and quickly find and convince investors. Moreover, to list shares in Hong Kong, it is enough to simply register the issue according to clear rules, whereas on the mainland, permission from the authorities is required. Beijing is gradually easing restrictions, but liberalization is still far off.
And most importantly, money invested in a Chinese company through Hong Kong can always be taken back, since the Hong Kong dollar is a freely convertible currency, and its exchange rate is pegged to the US dollar. Meanwhile, the yuan's exchange rate is in the hands of the Chinese authorities, and the export of capital from the mainland is strictly controlled.
This prevents the yuan from becoming a currency for international settlements. China is increasingly using it in bilateral transactions with its partners, but for free circulation, a market with a full set of financial instruments is needed. Hong Kong is ideally suited for this role, believes exchange head Li.
The development of the market and the transition to free convertibility of the yuan is a long process. Without Hong Kong, it will drag on even longer, delaying Beijing's dream of overtaking the US and challenging the dollar as the world's reserve currency.