VOLUME 12, ISSUE II - FEBRUARY 2010

Hong Kong

One common concern I discovered in both Hong Kong and Taipei was over the perception of growing tension between the U.S. and China. One of our interlocutors saw long simmering trade disagreements – especially those involving the currency exchange rate and inadequate protection of intellectual property – as boiling over this year. He added that successfully managing our differences with China would not be helped by China's overarching self-confidence, which he said is now bordering on the arrogant as Beijing watches the U.S. and much of the developed world continue to struggle with a global recession from which China has already emerged.

This theme was amplified further in a separate conversation with a former U.S. official. He extended the list of contentious issues likely to trouble our relationship with China this year beyond just trade to also include U.S. arms sales to Taiwan, differences over Iran and China's military. On the last point he noted the progress China has been making with its nascent missile defense system and the high probability that Beijing would acquire its first aircraft carrier sometime this year. He too, saw a certain degree of Chinese triumphalism, and a recent tendency for Beijing to see the U.S. in decline even as China continues to rise.

As an example of this he pointed to the events in Copenhagen last December, noting that the U.S. and China have disagreed on a host of issues but until now our disagreements have been carefully conducted in the spirit of mutual respect and with proper regard for protocol and “face.” In Copenhagen the Chinese side refused requests by the U.S. side to meet for the most part, and when they did send a representative he was well below the rank of American participants. The final straw was when Obama literally had to “crash” a meeting between Premier Wen Jiabao and his BRIC (Brazil, Russia, India, China) counterparts in order to get a meeting with Wen. Our interlocutor felt that China's behavior toward the U.S. in Copenhagen was intended as a deliberate slap in the face to Obama.

The day before our arrival in Hong Kong, angry demonstrators took over much of the Legislative Council (Legco) building and the streets around it to protest Legco's vote that day to approve approximately US$16 billion to construct a high speed rail link that would connect Hong Kong to China's high speed rail network. Demonstrators were protesting the high cost of the project and the displacement of hundreds of people (including one entire rural village) that the project would necessitate. When this subject came up in our conversations, it was sometimes used to illustrate how Hong Kong is changing. Hong Kong has always had protests, to be sure, but there is a sense now that the protests are becoming more confrontational and violent. Underlying somewhat the more confrontational nature of Hong Kong demonstrations is a growing politicization and polarization of views on governance in Hong Kong, i.e., whether to press for universal suffrage and unmixed democracy, or continue to follow the current system. Tensions may well heighten – not only in Hong Kong, but between Hong Kong and Beijing – as key dates come up later this decade for changing Hong Kong's system of governance under provisions of the Basic Law. Several of Legco's lawmakers, all of them pro-democracy, were threatening in mid-January to resign from Legco in order to force a by-election, which would in effect be a referendum on democracy for the SAR and faster movement toward direct elections. (Note: five members of the minority Civic Party and the League of Social Democrats did in fact resign from Legco in late January.)

Hong Kong's port is still a major driver of the SAR's economy. In 2008 the Port of Hong Kong was ranked third globally with Singapore and Shanghai holding the first and second slots. However, Hong Kong is facing growing competition from Pearl River Delta ports, especially from neighboring Shenzhen and its port, Yantian, which was ranked fourth globally in 2008. Yantian has been gaining on the Port of Hong Kong in container traffic because of its proximity to Guangdong Province's manufacturers and shippers and because its fees are cheaper. Yantian is taking enough business away from Hong Kong Port that plans to build a tenth container terminal have been suspended at least temporarily, because of uncertainty over whether there will be sufficient volume in the future to justify it.

Although Hong Kong Port is losing some market share to Yantian, it will continue to have several competitive advantages including greater reliability, faster turn-around times (because of more frequent sailings) and simple, transparent and relatively inexpensive customs and other procedures. Thus, for cargo that is high value and time critical Hong Kong remains the preferred port.

It is probably not too much of an exaggeration to say that Hong Kong is in a near-continuous process of reinventing itself. It has certainly been thus since the dawn of reform and opening in China in 1978, as Hong Kong began to realize then that its time honored role as China's entrepôt and principal gateway would soon give way to direct access to the Mainland.

In the latest version of reinvention, Hong Kong's chief executive, Donald Tsang, has identified six potential drivers of future economic growth in the Hong Kong SAR: educational services; 2) medical services; 3) testing and certification; 4) environmental industry; 5) innovation and technology; and 6) cultural and creative industries. Hong Kong has also recently fashioned itself into the Asian wine hub. All beverages with less than 30 percent alcohol are tax exempt. French wines predominate but California wines are gaining traction thanks to that state's aggressive marketing campaign. Locals with whom we spoke about this believed that Washington wines also should do well, but opined that Washington seems not to be paying attention thus far. Finally, medical tourism to Hong Kong is also growing in importance, especially among the relatively affluent on the Mainland.

Hong Kong's time honored role as the principal financial center for the region is being augmented by Mainland businesses looking for investment opportunities abroad. Hong Kong providers of financial services are increasingly focusing on this aspect. The Hong Kong Trade Development Council urged us to prepare a briefing on Washington State and the greater Seattle area to present to a group of Hong Kong financial service providers when we bring our delegation to Hong Kong in September. The local industry is looking for such material in order to assist their mainland clients. Reflecting somewhat the SAR government's economic development priorities, the U.S. Department of Commerce's targeted sectors in Hong Kong include education; wine; agriculture and food products; tourism; venture capital and finance; and green buildings/construction.

Although we did not travel to Zhuhai on the advance trip the Zhuhai Aviation Industry Park Economic and Trade Development Bureau dispatched its Deputy Director to meet with us in Hong Kong. The Park boasts an airport with one of the longest runways in the world – 13,000 feet – at its core. Businesses within the Park currently undertake parts manufacturing and aircraft maintenance and repair (including jet engines). The eventual goal for the Park is final aircraft assembly, first for business jets and then for commercial jets. China's only international air show is located in Zhuhai. This year will mark the eighth annual show, which will begin November 6.

Zhuhai's population is 1.5 million. Per capita GDP is US$9,700, the third highest in China. Zhuhai has been designated a ‘national garden city.” There are ten universities within the city, all of them branches of China's top schools. Passenger rail service connecting Zhuhai with Guangzhou will be finished this year. A separate rail link for freight is also nearing completion. Construction on the bridge to connect Zhuhai with the east bank of the Pearl River estuary and Hong Kong will begin this year and be completed in 2015. In the meantime, ferry service remains the most expeditious means of traveling between Hong Kong and Zhuhai.

Since the election of Ma Ying-jeou as president in the spring of 2008, both Taiwan and Mainland China have sought to end the mutual hostility and suspicion that characterized the eight years of Chen Shui-bian's presidency. Direct talks, broken off in the late 1990s, were resumed shortly after Ma took office in May 2008. Since then Taiwan and the Mainland have conducted four rounds of talks that have resulted in 12 agreements including one governing direct flights between Taiwan and 27 Mainland cities. Other agreements involve the financial sector, food safety, tourism, agriculture and police cooperation, among others.

The centerpiece of the fifth round of talks will be the cross-Strait Economic Cooperation Framework Agreement (ECFA), and negotiations should begin shortly. Other subjects on the table for resolution include better protection for IP, avoiding double taxation, currency convertibility, investment and open borders for residents of both sides.

With regard to the ECFA, each side undertook individual feasibility studies in 2009. A joint study – basically a melding of the two individual studies – was also completed late in 2009. The joint study will form the basis for actual negotiations of the ECFA which both parties hope can be completed and the agreement signed by the middle of 2010.

From 2000-2008 the Chen Shui-bian administration maintained a closed policy toward the Mainland. Restrictions on commercial relations with the Mainland damaged Taiwan's position in the global supply chain. Concluding the ECFA with the Mainland would formally reverse the policy of the past decade. This will not only be a direct benefit to Taiwan, but could also open the way for Taiwan to conclude free trade agreements with others such as Japan.

Nevertheless, despite the benefits to Taiwan's economy, ECFA has also raised popular concerns about possible loss of autonomy. President Ma Ying-jeou and his administration thus far have refused to make public exactly what will be negotiated under the ECFA. His excuse is that he doesn't want to tip Taiwan's hand in the negotiations. However, the PRC already knows precisely what the terms that will be negotiated are. This leads to the conclusion on Taiwan that there could be things under discussion that if enacted in an agreement would be distressing to those on Taiwan, such as surrendering some of its autonomy.

Because of this and several political blunders over the past year, President Ma has lost a considerable amount of popularity. Former President Chen Shui-bian's party, the Democratic People's Party (DPP) could regain power in 2012, although Chen himself won't be a contender (indeed, he could well be in jail by then). Moreover, the DPP's political center of gravity has shifted significantly since the last presidential election in 2008. As one interlocutor described it, no one on Taiwan is challenging any more the idea that Taiwan must be oriented toward the Mainland. The only questions are how much and in what manner. It is highly unlikely that the DPP's present or future leadership would pursue a closed Mainland policy and seek recognized independence the way that Chen Shui-bian did.

Taiwan's economy has been negatively impacted by the global recession. The Mainland is now Taiwan's largest export market (it used to be the U.S.), but much of Taiwan exports to the Mainland have been components for assembly into final products there to be re-exported to the U.S. and other markets. Those markets nosedived in 2009, dragging Taiwan exports to the Mainland down as well.

Taiwan's economy is now 70 percent service based. What remains of the industrial sector is export-led, but IT driven. Taiwan's export sector has been seriously hurt not only by the global recession, but also by stiff competition in the chip industry (especially DRAM) from Korea. Unemployment is high by historical Taiwan standards at about 6 percent.

There were many on Taiwan who anticipated (or at least hoped) that the island's growing rapprochement with the Mainland would become a vehicle to transform itself into global centers of logistics and finance, perhaps even replacing Hong Kong as the principal gateway to China. This hasn't happened so far and there are some significant reasons why it probably won't.

On logistics we heard that Taiwan is going in the wrong direction. Kaohsiung in southern Taiwan was one of the top five ports in the world just a few years ago; now it is barely in the top twenty. The value of outbound shipments remains high because of the large amount of high value chip exports to the Mainland. But in terms of container volume, Mainland ports and those in the Pearl River Delta in particular are eating Taiwan's logistical lunch.

On finance, others maintained that Hong Kong will continue to be the principal financial center for East Asia, because its currency is fully convertible and there are no foreign exchange controls. Taiwan's currency is fully convertible as well, but there are strict controls on FX. The PRC currency lacks both convertibility (on the capital account) and also has rigorous FX controls.

Still, expectations are high for economic recovery going into 2010. A modest stimulus package in 2009 featuring cash disbursements, tax breaks and low interest loans has helped soften the worst effects of the downturn. With the Mainland's GDP growth rate again nearing 10 percent and with economic recovery apparently underway in the U.S., Taiwan's economy should do well this year.

Among the targeted sectors identified for us the environmental sector was at the top. A big piece of Taiwan's US$100 billion infrastructure development fund is dedicated to the environment (note: the fund is financing 12 major infrastructure projects). We were also advised that Taiwan is seeking opportunities to invest in the U.S.' solar equipment industry. Green buildings/design/materials/construction is also on the list.

Life sciences and health care are also targeted sectors, including health care management and medical tourism. Taiwan offers first rate medical equipment and professional medical skills, but at third world prices. Despite robust FX controls banking and finance could offer some additional opportunities now that Taiwan banks are about to open branches in the PRC.

With regard to education, Taiwan is the sixth largest supplier of foreign students in the U.S. (Canada is fifth largest, but with only about 100 more students here than Taiwan). 97 percent of U.S. visa applications by Taiwan students are approved. Taiwan students are almost 100 percent self financed and are not dependent on scholarships.

Tourism is also big. Taiwan is among the top ten feeding the global tourism market. In addition there are four million visits from Taiwan to the Mainland each year (there are 850,000 Taiwanese residing on the Mainland).

Since our business mission this year will include Taipei, Hong Kong and Zhuhai, we will be reporting again on these places in future Updates. You can check http://www.seattletradealliance.com/blog/?p=2004 for more details about the mission. Additional information will be available at the URL above and on our website (www.wscrc.org) soon.