Hong Kong Growing as Part of China:
A Historical Perspective

Y.C. Richard Wong at the Asia Society Conference:
"Hong Kong One Year After Transition: Business
Opportunities and Policy Challenges"

June 15, 1998

Introduction

The story of the emergence of Hong Kong as a modern metropolis from a small fishing village on the South China coast is now standard fare in almost all history books about the territory. What is left untold in this caricature is that Hong Kong was a busy crossroads of trade and cultural intercourse. Indeed, Hong Kong's fortunes rose and fell with its changing relationship with the Chinese mainland over two millennium

With sovereignty over Hong Kong having been restored to China from Britain on 1 July 1997, it is useful to recount the real history, review the period under British rule, so as to find our bearings for the future. This historical perspective is especially important for it puts into perspective the British contribution to the economic development of Hong Kong, especially in the post-war period. It also puts into perspective the many economic and social policy debates that are surfacing now and will be developing in the years ahead.

Hong Kong's relationship with the Chinese mainland is fundamental in defining the shape and scope of economic and social affairs in the territory. It sets in motion forces that in their totality determine the environment for public policy choices which the Hong Kong government faces not only in political affairs but also economic and social matters. The government's choice of a light handed approach to public policy in the post-war period is often considered to be a unique British contribution even though Britain did not adopt it for herself. Yet to what extent was the laissez faire approach to governance compelled by Hong Kong's fundamental relationship with the Chinese mainland is an open question that deserves investigation. For those who believe that Hong Kong's laissez faire economic system was responsible for the post-war economic miracle, the answer will be of great relevance in forecasting the economic future of the territory.

The Period before British Rule

The term "Barren Island" was apparently first used by Lord Palmerson, British Foreign Secretary, who dismissed the acquisition of Hong Kong as that of "a barren Island with hardly a House upon it". A census in 1841 put the inhabitants on the island at about 7500. But the waters and the area around the island were since historical times and long before the British arrived, a natural crossroads between East and West and a gateway to China. This is borne out by archaeological findings and written records that date back some two millennium. The Tuen Mun area (which could mean the area from modern day Lantau to today's Tuen Mun to Nantou in present-day Shenzen) was the first port of call after crossing the South China seas as early as the fourth century. A modern day observer may well marvel at the obvious coincidence that Hong Kong's container and river boat terminals, which handles the largest volume of throughout in the world today, is located in the same area. Indeed the future airport at Chek Lap Kok scheduled to open next year will also be situated there.

Historically the Pearl River estuary region was well known for its salt pans. After the Han conquest of Nanyue in AD 111 an imperial outpost to administer the salt monopoly was established in Panyu, to the northwest of present-day Hong Kong. In the Tang Dynasty trade flourished in the city of Guangzhou, which had a monopoly over foreign trade, and there was a reported colony of foreign traders over 100,000 strong. For many centuries, Tuen Mun served as an outer port for Guangzhou, a naval base, a center for religion, and a production center for salt.

In the Song dynasty the administration of the government salt monopoly was relocated to present day Kowloon City next to the existing Kai Tak airport, known at time as Guanfu. As a religious center Tuen Mun played host to Buddhist Monks and Islamic mullahs. It is therefore not accidental that even today's Tuen Mun and Lantau are still renowned for their Buddhist, Taoist and Catholic monasteries.

Nevertheless the Tuen Mun area went into decline after the Mongols successfully invaded China and founded the Yuan dynasty. In the war against the Mongols the Tuen Mun area was devastated for having supported the ill-fated last Song emperors in its final resistance. The customs points were subsequently moved from the Tuen Mun area north up the Pearl River to Huangpu and Tuen Mun was reduced to a mere anchorage.

The Ming Dynasty that succeeded was extremely insular and banned all forms of foreign trade except tribute trade for many years. This led to the growth of large illicit trade in the area, coastal piracy, and numerous military adventures where foreigners were also engaged, primarily the Portuguese and Japanese. Trade was finally legitimized because of the inability to stamp out piracy but the Tuen Mun and Guanfu area did not recover.

Worse was to come in the Qing Dynasty when the Ming loyalist Zhen Zhengong retreated to the island of Taiwan. He continued to harass the China coast forcing the Qing court to adopt in 1622 a policy of "moving the territories". All land within 25 kilometers of the seacoast was abandoned. The population had to be evacuated and the buildings demolished so that no food or assistance would be available to the loyalists. Most of present day Hong Kong was affected.

The policy of "moving the territories" was subsequently abandoned in the 1669, but re-population was only allowed after 1683. Most of those who came were Hakkas (a term used to describe non-native immigrant groups). Trade was restored in a number of coastal cities, but was later restricted to the city of Guangzhou and the Macau settlement. Tuen Mun and Guanfu ceased to be an outer port for Guangzhou and became mainly a lair for pirates who preyed on the lucrative trade. A legendary woman known as Zheng Yisao and her common law husband Zhang Bao led the most active pirates. They had some 20,000 to 30,000 followers and their field of operation stretched from Vietnam to Gujian. The Hong Kong waters were used as their base.

There is some circumstantial evidence to suggest that trading activities started to develop in Hong Kong after the eradication of the pirates by the Chinese navy. The British opium traders in particular used Hong Kong waters for moorings, and relied on the migrant Hakkas to be the purveyors, commissariat and transport coolies of the foreigners and the Tankas, who were the local fishing population, to provide boatmen and pilots for the foreign trade.

From this limited record of Hong Kong's early history two points stand out. First, the territory was a natural crossroads for trade and cultural intercourse since time immemorial by virtue of its geographic location and natural endowments. Second, the territory thrived in the Tang and Song dynasties when the government in China pursued an open door policy, and declined in the Yuan, Ming and early Qing dynasties when policies turned inwards and became insular. The forcible opening of China in the Qing dynasty resulting in the Opium wars and the loss of Hong Kong to Britain heralded a new chapter in the development of Hong Kong.

From Barren Island to Refugee Haven

The establishment of British rule provided Hong Kong with a certain degree of insulation from policy decisions in China. Hong Kong could pursue its own natural advantages in trading activities with limited interference from China. It also coincided with British interests in Hong Kong which was to use it primarily as a trading post. Given the importance of trade to Hong Kong' s economic livelihood it was not surprising that Hong Kong was declared a free port. Although the opium trade dominated at the beginning, over time it gave way to other merchandise trade with the expansion of entrepot trade with China.

One of the distinguishing features of trade with China was to navigate through its customs bureaucracy and to penetrate the domestic market. British traders relied heavily upon Chinese middlemen, even for opium trade. The Chinese merchant class grew rapidly both in numbers and in wealth. A survey in the late nineteenth century found that Chinese families far outnumbered all others among the wealthiest group in the territory.

As the economy expanded workers from the mainland streamed into Hong Kong. In the period from 1842 to 1949, population flow between Hong Kong and China was unrestricted except during the war years. The workers who came to Hong Kong during those years were predominantly men who came in search of jobs while their families remained behind. It was only much later that some of their families started to join them. The earliest records showed that in 1845 out of an estimated total population of 23817 there were 19201 men, 2862 women, and 1754 children. The sex balance improved over time as more families came to settle in Hong Kong. Nevertheless large numbers of people would continue to move backwards and forwards between Hong Kong and the Chinese mainland. It was not uncommon for 10-20 percent of the population to leave Hong Kong and return to the mainland in any one year, and in some years it was as high as 35 percent.

The fact that the population flow between the Chinese mainland and Hong Kong was restricted suggests that there were no significant differences in the standards of living between the two areas. This suggests that although there were many Chinese families who accumulated vast fortunes as a result of their trade activities, the vast majority of the laborers were unlikely to have prospered. Indeed life in Hong Kong was far less entertaining and exciting than Shanghai, which was then clearly the leading industrial and commercial center of China.

The predominance of recent migrants and sojourners within the population generated very little demands on the government to provide public assistance or service. Private charities and missionaries were the main sources of social support and service. On the whole it was both possible and expedient for the government to adopt a light handed approach to social intervention. Public expenditure and revenue were kept simple and for many years the government opium monopoly provided most of the public revenue. Indeed the only well organized group who stood up to defend its own interest was probably the indigenous rural inhabitants in the New Territories who have succeeded in protecting their special privileges to this day.

The fortunes of Hong Kong took a very dramatic turn at the end of the Second World War when refugees escaping the ravages of a civil war and the uncertainties of its outcome streamed into Hong Kong by droves. The population of Hong Kong rose from 600,000 at the end of 1945 to 2.1 million in 1950. When the Chinese Communist Party came to power the border was effectively closed on the Chinese side to prevent people from leaving.

The refugees who arrived were mainly laborers and farmers from Guangdong province, but they also included numerous entrepreneurs and industrialists who arrived from Shanghai. These businessmen brought management and technical know-how and market knowledge from one of the most advanced economic centers in Asia. They represented numerous industries, including manufacturing, retail business, banking , movies, shipping, and professions. This concentration of skills was much broader that the trading activities that existed in Hong Kong.

By a curious turn of events, Hong Kong's traditional advantages in entrepot trade came to a halt after the Korean war broke out and the United States imposed a trade embargo against China. The combination of external events turned Hong Kong into an autonomous economic entity in so far as the Chinese mainland was concerned. Export oriented manufacturing production replaced entrepot trade to become Hong Kong's new comparative advantage. These manufacturers were able to obtain credit from the banks in Hong Kong and to work with the British trading companies in entering first the Commonwealth market and later the North American market.

Both as a matter of necessity and out of conviction the government continued to pursue a light handed approach to economic policy and allowed Hong Kong's businessmen to pursue economic gains in accordance with market signals. The response of the Hong Kong government to the imposition of voluntary export restraints by the US government through the Multi-Fiber Agreement is exemplary and unique among victimized economies. The Hong Kong government instead of trying to administer the quotas directly chose to allocate them to the manufacturers in proportion to their historical production figures at no charge and allowed them transfer the quotas freely at market prices.

The fact that these new entrepreneurs were recent immigrants also reduced the level of business lobbying, which would otherwise have led to more government intervention. The view that the British government in Hong Kong had a high discount rate is consistent with the view that they had little urge to indulge in grandiose schemes to promote economic development, but was much more concerned that Hong Kong would not become a burden of the home government. And, finally, the British government probably recognized that their mandate to govern was in the final analysis at the pleasure of the Chinese government and the acquiescence of the local population.

The contrast between Hong Kong and Singapore is obvious. Singapore's natural advantages like that of Hong Kong was in entrepot trade and not export oriented manufacturing. But unlike Hong Kong she did not receive an infusion of entrepreneurial talent on the eve of its independence and she never lost her advantage in entrepot trade due to external forces. As a consequence, Singapore had developed her manufacturing base in the absence of favorable market signals. As a young and independent nation struggling to find its rightful place among suspicious neighbors, the government embraced enthusiastically numerous interventionist policies to attract and target foreign investments into manufacturing with the support of forced savings mobilized through a central provident scheme that required mandatory contribution of 40 percent of earnings.

The renowned entrepreneurial spirit of the Hong Kong business men may well be due to the self selection process of an immigrant population and the minimalist policies of the government that provided clear, simple and predictable rules of the game, including taxes, which facilitated the taking of risks and the accumulation of wealth that is not readily found in most other places. I have often wondered if economic integration between Hong Kong and the mainland would have proceeded so quickly if, on the eve of China's opening, Hong Kong was more like Singapore and lacked a large contingent of energetic entrepreneurs that was ready to take risks in the mainland.

To be sure the government played a very large role in the provision of public housing, public health care, and education subsidies. The historical genesis of this large involvement can ultimately be traced to the sudden influx of a large refugee population in the late 1940's. The fact that Hong Kong was totally unprepared and the responses to them took the shape of a series of ad hoc measures that had path dependent consequences were primarily responsible for this state of affairs.

The closing of the borders between Hong Kong and the Chinese mainland ushered in an era in which Hong Kong's economic environment was further insulated from events with in China. A series of historical events resulted in a fundamental shift in Hong Kong's economic advantage. Perhaps the most important reason for the post war economic miracle is the influx of vast amounts of human capital, whose value was maximized through a light handed government policy that respected market signals. In this period, as a result of its relative isolation from the Chinese mainland its location as the gateway to south China became of minor economic importance. The situation would be changed with the opening of China in 1979.

The Permeable Border

The momentous impact of China's opening to Hong Kong is highly visible. Within a span of 18 months between 1980 and 1981, some 400,000 individuals crossed the border into Hong Kong. The impact on labor market conditions was swift. Real wages failed to grow for several years, but Hong Kong's labor-intensive manufacturing industries received a new lease on life as competitiveness was restored with the injection of a new army of workers.

Nevertheless, the sudden influx quickly led to an agreement between Chinese and Hong Kong authorities to regulate and limit the flow to 75 individuals per day as a result of public concern over its consequences on labor markets, social-education, housing, health, and infrastructure services. Although the number has been increased to 150 over time, illegal flows continue to be a permanent problem.

The fear of population inflows from the mainland continues to be a cause of anxiety to many local residents. However, there is clear difference in the attitude of capital and labor towards such inflows. Capital typically welcomes them, but labor is both angry and jealous.

The opening of China began to have an even more perceptible impact on the economy as our manufacturing base migrated Northwards across the border. At its peak, our manufacturing enterprises employed some 900,000 workers in Hong Kong. Today they reportedly employ as many as six million workers on the mainland, with less than 250,000 in Hong Kong.

These changes have important social dimensions that have had an enormous impact on the lives of individuals and families in Hong Kong. As many as 500,000 workers have had to seek new jobs in service industries as manufacturing jobs were lost in mid-life. Organized labor in Hong Kong since found an enduring agenda in free market - hostility to labor inflows - an alien concept throughout the history of Hong Kong, where most inhabitants before the war were sojourners and those after the war are first or second generation immigrants.

Today, hundreds of thousands in our work force commute regularly across the border to work on the mainland and millions from Hong Kong enter China every year for short visits. As social and economic contacts continue to grow between the two, rising number of marriages are now taking place between Hong Kong and mainland residents.

The presence of draconian laws to limit the flow of individuals from China into Hong Kong has created a heart-wrenching phenomenon. An increasing number of families now have members who are forced to live apart for years, separated by a border. The sight of children and mothers torn from their loved ones forcibly repatriated back to the mainland is a familiar one on television.

The human cost is immense today. Tomorrow it will be even more staggering as numbers and the prolonged agony of those waiting to be united keeps growing. it is inconceivable how people living in two economies and societies so close to each other with such intense contact will fail to develop such ties and relations.

Divided families lead eventually to a society of alienated individuals, fostering social divisiveness. The day of reckoning for Hong Kong will arrive when the social pressures of a distorted family life, a lonely and isolated childhood, maladjusted youth and lasting memories of despair, humiliation, anxiety and unfulfilled promises finally erupt in full force. Hong Kong will pay dearly for its current policies to regulate and limit population inflows, but the choices are limited.

In contrast to these worrying social forces that have been released by the opening of China, the economic impact on Hong Kong is far more positive. The enormous complementaries between the mainland and Hong Kong have created numerous opportunities for economic co-operation to the benefit of both Hong Kong and the mainland. While the easiest areas of co-operation have probably been exploited and further integration would require liberalization and deregulation to proceed even further on the mainland. However, even very modest progress in these areas would generate enormous opportunities for Hong Kong businessmen.

Nevertheless, the huge economic strides made by Hong Kong have a price. Given that Hong Kong operates an exchange rate regime that is similar in many respects to the currency board system and is linked to the US dollar, consumer price inflation has outstripped price inflation of tradable goods. This is a familiar situation in many fast growing economies where productivity of the tradable sector rises faster than the non-tradable sector. Inflation is now a permanent feature of an economy that is always operating at full capacity, even during cyclical downturns. The capacity constraint is to a large measure a result of the policy to regulate and limit the inflow of population and labor from the mainland.

The damaging effects of inflation are most serious in its impact on savings. Families in Hong Kong have little choice but to buy property as a means to protect their savings, thereby further fueling property prices in a market already suffering from ever shortages. Property ownership today divides society into the "haves" and "have-nots"; and the gulf that separates them appears to be ever widening.

Rising property have implications for a whole range of policy choices. The retired population finds their pensions and savings to be unable to support the lifestyle they had planned for and are lobbying for public assistance and old age security support. Their numbers are growing as the population ages and they will make voices heard at the ballot box.

Industrialists blame high housing costs as having driven up wages and make them less competitiveness than their neighbors. They have called upon government to support technology and enhance productivity to support their operations in Hong Kong and the mainland. They have also lobbied for a more liberal system of arranging work permits for workers, technicians, and engineers on the mainland to come to Hong Kong.

These conflicting voices have one thing in common and that is to invite government intervention in one form or another that was previously either not present or unheeded. They are ultimately the consequences of a border that has become more permeable but not completely so. Some lobby for greater permeability others for less permeability. Permeability is seen both as a curse and a blessing.

Managing the Permeable Border

By any yardstick, 1997 will be a significant year for the future of both Hong Kong and China. However, it was the economic and social forces unleashed in 1979 in China's open door policy and Hong Kong's response to them that may ultimately determine our fate.

Given the disparity in the level of economic development and the differences in the economic system between Hong Kong and the mainland, there are obvious benefits to greater integration and this entails making the border more permeable. Yet the privileges and scarcity rents that accrue to Hong Kong residents are ultimately derived from the fact that the border must remain non-permeable to some extent.

Managing the permeability of the border has to become an integral part of all economic and social policies within Hong Kong as the two matters will have implications for each other. The period prior to 1949 was one where there was perfect permeability and standards of living were similar between Hong Kong and the mainland. The period between 1949 and 1979 was one where there was essentially no or very limited permeability and standards of living were therefore permitted to diverge between the mainland and Hong Kong. In both periods the government was able to pursue a laissez faire system without any fundamental inconsistency. This is no longer the case with the opening of China. With the border being quasi-permeable and great disparities in standards of living and differences in the economic system it is no longer obvious that the laissez-faire system will maximize local welfare or be politically feasible.

Nevertheless there will be certain policies that would better preserve the vitality of a market system based on free enterprise and individual responsibility. For example, Hong Kong could adopt a policy to sell the existing stock of public housing to sitting tenants as a solution to many problems. The lease can take place at prices below market levels and tenants should be allowed to have the right to transfer the unit on the free market and to keep any capital gains that arise from the sale.

With more than a third of our households living in public housing, privatization would provide them with a genuine asset that could be an effective hedge against inflation. The asset could be used as collateral for financing business activities, as an annuity to provide for old age retirement or as a bequest to loved ones. At almost no cost to society, the inseparable gulf between the "haves" and "have-nots" would be largely eliminated.

As Hong Kong becomes a predominately propertied society, the hostility of local residents toward immigrants will be greatly reduced. The arrival of immigrants will be perceived to enhance property and capital values, and not depress wages and take away jobs.

If the government adopts a clear, credible policy to allow spouses and children of Hong Kong residents to arrive in Hong Kong after July 1 anytime they wish, it need not trigger an immediate rush into Hong Kong. Most parents are, after all, responsible individuals who will not send for their dependents until arrangements for setting them up in Hong Kong have been made.

In the longer run, such policy would also enhance the attractiveness of local residents as marriage partners for mainlanders, while Hong Kong would be able to attract better quality immigrants through marriage. Children from these marriages would be able to benefit from a better quality education here. Indeed Hong Kong has much to gain from long-term policy to reunite separated families. Such a policy would also entail making provision for Hong Kong to develop as a metropolis with a population that is much larger than is currently contemplated in official forecasts.

The intellectual and political challenge for Hong Kong to manage her integration with the mainland is enormous. Only time will tell whether we will be successful and as Hong Kong's own past history has shown there may well be events that are beyond our control and influence. The prize, if we are successful, is that we would have won over one fourth of humanity. And that is a worthy goal.


Y.C. Richard Wong is Director of The University of Hong Kong School of Business.