Hong Kong 10 Years On

Interview

Hong Kong 10 Years On

Ten years after the return of Hong Kong to China, the city highlights its advantages in the face of increased competition from the Mainland

Evan M. Thorpe, Business Advisory Services manager at the US-China Business Council (USCBC) in Washington, DC, recently asked Richard Margolis, a former UK diplomat in Hong Kong who is now regional director of Rolls-Royce International Ltd.'s Northeast Asia division, for his views on Hong Kong's trade and investment environment.

USCBC: July 1 will mark 10 years since Hong Kong's return to China. What are the top three changes in Hong Kong since then, particularly in the business environment?

Margolis: Though some people assume that changes in Hong Kong's business environment have come as a result of the handover, this premise doesn't accurately reflect the true condition of Hong Kong. In my view, problems in Hong Kong's business environment since 1997 are largely unrelated to the handover. The handover was eclipsed by many other changes that had a far greater direct impact on Hong Kong's economy and business environment, such as the Asian financial crisis of 1997 and Mainland China's growing ability to trade directly with the outside world rather than using Hong Kong as an intermediary.

Prior to the handover, many commentators viewed political risk in Hong Kong as a variable. The optimists thought it would disappear completely when Mainland China resumed sovereignty, and the pessimists thought it would overwhelm Hong Kong. But in fact, political risk in Hong Kong is a constant, not a variable. It exists simply because Hong Kong is vulnerable to China, given that it imports 80 percent of its drinking water and half its food from the Mainland. China's leaders have therefore always had the option to retake control of Hong Kong, a fact that did not change on July 1, 1997.

Since the handover, Hong Kong has faced challenges tied to its system of government. With an elected legislature and an appointed executive, Hong Kong is in the slightly curious position of being able to elect the opposition, but not the government. This makes Hong Kong political life a bit fractious at times, but the impact on business has been marginal. What has not changed: lively free press, frequent demonstrations, and the Hong Kong police's efficiency in crowd control.

USCBC: China's rapid development has brought new challenges and opportunities to Hong Kong. Please describe some of these challenges and opportunities and how Hong Kong is addressing them. What are Hong Kong's strengths and weaknesses in this regard?

Margolis: In terms of strengths, in recent years the key actors that have led to Hong Kong's success are still in place: a trusted legal and contracting system with trustworthy courts, open capital markets, and a fully convertible currency. This gives Hong Kong a clear edge in trade finance and the provision of other financial services to the Mainland. The Mainland's banking sector has a long way to go before it can challenge Hong Kong in efficiency.

In terms of weaknesses, Hong Kong's system of land tenure (all land is acquired leasehold from the government), which has generated massive revenues to fund Hong Kong's infrastructure and public housing programs, may no longer be functioning in the best interests of the community as a whole. The land premium, which is a tax under another name, is anywhere from 50 to 60 percent of the total cost of a real estate project. Developers advance this tax revenue to the government and then recover it from the population with a margin—a modern form of tax farming. The extent to which this system makes Hong Kong a high tax environment in practice rather than the low tax environment it claims to be is, in my view, underanalyzed and largely ignored by policymakers.

USCBC: China's distribution facilities, particularly its ports, have vastly improved in the last 10 years. In addition, Shanghai seems to aspire to become the financial center of Greater China, and the Mainland's real estate sector is booming. These three sectors have been pillars of growth in Hong Kong for decades. How is the city maintaining its competitiveness in these sectors? What new frontiers or other sectors present opportunities for Hong Kong?

Margolis: Hong Kong occupies a leading position as a financial center thanks to the efficiency of its banks and the maturity of its capital markets. As for the growth of PRC ports, Hong Kong is benefiting from the growth of the Mainland market in general. Mainland China needs all of the efficient ports that it can get.

In terms of real estate, in the Mainland the prices for pre-owned homes are well below the market rate for new homes. Everyone wants to buy new. Though Hong Kong real estate leaders have all moved into the Mainland's market to fill this demand, they are not giants in the Mainland like they are in Hong Kong. They are smaller competitors in a very large market.

USCBC: How might Hong Kong's importance as a global financial center evolve as China loosens controls on its currency? How will this affect its positioning in the Mainland's domestic financial services market?

Margolis: There is more to a fully convertible currency and the benefits it provides than having a market-driven exchange rate. Clearly, Mainland China is heading toward a change in the exchange rate, but having a fully convertible currency does not just refer to the currency itself; the term suggests a currency in which anyone can borrow. In Hong Kong, anybody—regardless of nationality—can borrow any amount of money in any currency [if they can persuade a lender]. It may be some time before the renminbi gets to that point, even after a significant liberalization of exchange rate mechanisms. Bank efficiency is a major factor in this equation, and Hong Kong has an enduring advantage in this area.

USCBC: Hong Kong has benefited from the concentration of manufacturing in Guangdong. As costs rise for companies located along China's coast, companies are beginning to move inland. How will Hong Kong companies cope as manufacturing starts to shift inland, further away from the city? Are inland cities beginning to develop as Shenzhen and Guangzhou have, and do you see them as new sources of demand for the types of services in which Hong Kong has expertise?

Margolis: I think the Pearl River Delta (PRD) is likely to remain a key center of manufacturing and a key source of business for Hong Kong. It is likely to be easier to recruit workers from further afield than to move the factories. We have already seen how important migrant workers are to Mainland China's growth.

Hong Kong's relationship with Mainland cities is defined by the relationships it has with people doing business in those cities. Hong Kong's strength is the large network of manufacturing companies whose managers are anchored to banking and other relationships in the SAR [Special Administrative Region]. It doesn't matter where companies expand their networks in the Mainland—as Hong Kong bank branches open to serve those areas, these relationships remain key.

USCBC: How would you describe Hong Kong's sustained regional importance as a location for Asia-Pacific headquarters? How has Hong Kong built upon this foundation over the 10 years since the handover?

Margolis: Hong Kong and Singapore tend to assert that the number of company headquarters located in a given city is a key determinant of the city's success and standing. I don't subscribe to this point of view. Headquarter location choice is driven by the individual business priorities of multinational corporations (MNCs), and the value of a city is not tied simply to the number of regional headquarters located there. Headquarter functions generate little value, since most MNCs have flat management structures, and the regional manager spends most of his or her time on planes.

Hong Kong's attractions as a place to do business are pretty clear. Hong Kong is conveniently located for China and one of the world's most dynamic regions. Fifty percent of the world's population is within a five-hour flight. It also has fabulous infrastructure, a brilliant airport, and great flight connections. It has financial and legal systems in place that companies use for a lot of their contracting. The language of Hong Kong business is English. It has always had a magic in that most people who go there on an assignment love the place.

Of course, some people don't like it—it does have some drawbacks. For example, pollution has become much worse. Though there is debate as to whether this is generated from Hong Kong or washed down from the PRD. It is also an expensive place to put expatriate staff if they are to have similar lifestyles—for example, access to recreation facilities—to those that they would expect to have at home.

USCBC: What is the future of Hong Kong's role in your business?

Margolis: Hong Kong is home to one of Rolls-Royce's most important customers, Cathay Pacific Airways Ltd., owned by the Swire Group, which is also a major customer for Rolls-Royce's marine business. We also have a joint venture (JV) with the Swire Group that does aircraft engine repair and overhaul in Hong Kong. Other than the JV, Rolls-Royce's physical presence in Hong Kong is quite small—much of the relationship with the airline is managed directly from the United Kingdom.

We have a more extensive presence in Mainland China, where all the major airline groups operate Rolls-Royce engines and where our marine and energy businesses have significant activity. We also purchase a wide range of parts and materials in China and have a JV in Xi'an, Shaanxi, which manufactures turbine components. We have 230 direct employees and another 320 employees in the Xi'an JV. Mainland China business is growing rapidly from a lower base, whereas our Hong Kong business is more mature and focused on one major customer.

That said, Hong Kong remains a significant hub for regional aviation, and Cathay Pacific will remain one of our most important customers. Cathay Pacific, with its ownership of Dragonair [Hong Kong Dragon Airlines Ltd.], will expand its presence in China and throughout Asia. Their partnership with Air China Ltd. should also be an important source of growth for them.

Richard Margolis, Regional Director, Northeast Asia, Rolls-Royce International Ltd.

In 2003, Richard Margolis joined Rolls-Royce International Ltd. in Beijing, where he covers Greater China and South Korea. Margolis lived and worked in Hong Kong from 1981 to 2003. After a 14-year Diplomatic Service career during which he was posted in Beijing, Paris, and Hong Kong, Margolis moved to the private sector in Hong Kong in 1986. From 1995 to 2001, he worked at Merrill Lynch in various capacities, including as head of Strategy and Planning for Asia Pacific. During his five years as deputy political advisor to the governor of Hong Kong (1981–86), Margolis was closely involved with the United Kingdom-China negotiations on Hong Kong's future.

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	E-Mail \| Print \| License Interview Hong Kong 10 Years On Ten years after the return of Hong Kong to China, the city highlights its advantages in the face of increased competition from the Mainland Evan M. Thorpe, Business Advisory Services manager at the US-China Business Council (USCBC) in Washington, DC, recently asked Richard Margolis, a former UK diplomat in Hong Kong who is now regional director of Rolls-Royce International Ltd.'s Northeast Asia division, for his views on Hong Kong's trade and investment environment. USCBC: July 1 will mark 10 years since Hong Kong's return to China. What are the top three changes in Hong Kong since then, particularly in the business environment? Margolis: Though some people assume that changes in Hong Kong's business environment have come as a result of the handover, this premise doesn't accurately reflect the true condition of Hong Kong. In my view, problems in Hong Kong's business environment since 1997 are largely unrelated to the handover. The handover was eclipsed by many other changes that had a far greater direct impact on Hong Kong's economy and business environment, such as the Asian financial crisis of 1997 and Mainland China's growing ability to trade directly with the outside world rather than using Hong Kong as an intermediary. Prior to the handover, many commentators viewed political risk in Hong Kong as a variable. The optimists thought it would disappear completely when Mainland China resumed sovereignty, and the pessimists thought it would overwhelm Hong Kong. But in fact, political risk in Hong Kong is a constant, not a variable. It exists simply because Hong Kong is vulnerable to China, given that it imports 80 percent of its drinking water and half its food from the Mainland. China's leaders have therefore always had the option to retake control of Hong Kong, a fact that did not change on July 1, 1997. Since the handover, Hong Kong has faced challenges tied to its system of government. With an elected legislature and an appointed executive, Hong Kong is in the slightly curious position of being able to elect the opposition, but not the government. This makes Hong Kong political life a bit fractious at times, but the impact on business has been marginal. What has not changed: lively free press, frequent demonstrations, and the Hong Kong police's efficiency in crowd control. USCBC: China's rapid development has brought new challenges and opportunities to Hong Kong. Please describe some of these challenges and opportunities and how Hong Kong is addressing them. What are Hong Kong's strengths and weaknesses in this regard? Margolis: In terms of strengths, in recent years the key actors that have led to Hong Kong's success are still in place: a trusted legal and contracting system with trustworthy courts, open capital markets, and a fully convertible currency. This gives Hong Kong a clear edge in trade finance and the provision of other financial services to the Mainland. The Mainland's banking sector has a long way to go before it can challenge Hong Kong in efficiency. In terms of weaknesses, Hong Kong's system of land tenure (all land is acquired leasehold from the government), which has generated massive revenues to fund Hong Kong's infrastructure and public housing programs, may no longer be functioning in the best interests of the community as a whole. The land premium, which is a tax under another name, is anywhere from 50 to 60 percent of the total cost of a real estate project. Developers advance this tax revenue to the government and then recover it from the population with a margin—a modern form of tax farming. The extent to which this system makes Hong Kong a high tax environment in practice rather than the low tax environment it claims to be is, in my view, underanalyzed and largely ignored by policymakers. USCBC: China's distribution facilities, particularly its ports, have vastly improved in the last 10 years. In addition, Shanghai seems to aspire to become the financial center of Greater China, and the Mainland's real estate sector is booming. These three sectors have been pillars of growth in Hong Kong for decades. How is the city maintaining its competitiveness in these sectors? What new frontiers or other sectors present opportunities for Hong Kong? Margolis: Hong Kong occupies a leading position as a financial center thanks to the efficiency of its banks and the maturity of its capital markets. As for the growth of PRC ports, Hong Kong is benefiting from the growth of the Mainland market in general. Mainland China needs all of the efficient ports that it can get. In terms of real estate, in the Mainland the prices for pre-owned homes are well below the market rate for new homes. Everyone wants to buy new. Though Hong Kong real estate leaders have all moved into the Mainland's market to fill this demand, they are not giants in the Mainland like they are in Hong Kong. They are smaller competitors in a very large market. USCBC: How might Hong Kong's importance as a global financial center evolve as China loosens controls on its currency? How will this affect its positioning in the Mainland's domestic financial services market? Margolis: There is more to a fully convertible currency and the benefits it provides than having a market-driven exchange rate. Clearly, Mainland China is heading toward a change in the exchange rate, but having a fully convertible currency does not just refer to the currency itself; the term suggests a currency in which anyone can borrow. In Hong Kong, anybody—regardless of nationality—can borrow any amount of money in any currency [if they can persuade a lender]. It may be some time before the renminbi gets to that point, even after a significant liberalization of exchange rate mechanisms. Bank efficiency is a major factor in this equation, and Hong Kong has an enduring advantage in this area. USCBC: Hong Kong has benefited from the concentration of manufacturing in Guangdong. As costs rise for companies located along China's coast, companies are beginning to move inland. How will Hong Kong companies cope as manufacturing starts to shift inland, further away from the city? Are inland cities beginning to develop as Shenzhen and Guangzhou have, and do you see them as new sources of demand for the types of services in which Hong Kong has expertise? Margolis: I think the Pearl River Delta (PRD) is likely to remain a key center of manufacturing and a key source of business for Hong Kong. It is likely to be easier to recruit workers from further afield than to move the factories. We have already seen how important migrant workers are to Mainland China's growth. Hong Kong's relationship with Mainland cities is defined by the relationships it has with people doing business in those cities. Hong Kong's strength is the large network of manufacturing companies whose managers are anchored to banking and other relationships in the SAR [Special Administrative Region]. It doesn't matter where companies expand their networks in the Mainland—as Hong Kong bank branches open to serve those areas, these relationships remain key. USCBC: How would you describe Hong Kong's sustained regional importance as a location for Asia-Pacific headquarters? How has Hong Kong built upon this foundation over the 10 years since the handover? Margolis: Hong Kong and Singapore tend to assert that the number of company headquarters located in a given city is a key determinant of the city's success and standing. I don't subscribe to this point of view. Headquarter location choice is driven by the individual business priorities of multinational corporations (MNCs), and the value of a city is not tied simply to the number of regional headquarters located there. Headquarter functions generate little value, since most MNCs have flat management structures, and the regional manager spends most of his or her time on planes. Hong Kong's attractions as a place to do business are pretty clear. Hong Kong is conveniently located for China and one of the world's most dynamic regions. Fifty percent of the world's population is within a five-hour flight. It also has fabulous infrastructure, a brilliant airport, and great flight connections. It has financial and legal systems in place that companies use for a lot of their contracting. The language of Hong Kong business is English. It has always had a magic in that most people who go there on an assignment love the place. Of course, some people don't like it—it does have some drawbacks. For example, pollution has become much worse. Though there is debate as to whether this is generated from Hong Kong or washed down from the PRD. It is also an expensive place to put expatriate staff if they are to have similar lifestyles—for example, access to recreation facilities—to those that they would expect to have at home. USCBC: What is the future of Hong Kong's role in your business? Margolis: Hong Kong is home to one of Rolls-Royce's most important customers, Cathay Pacific Airways Ltd., owned by the Swire Group, which is also a major customer for Rolls-Royce's marine business. We also have a joint venture (JV) with the Swire Group that does aircraft engine repair and overhaul in Hong Kong. Other than the JV, Rolls-Royce's physical presence in Hong Kong is quite small—much of the relationship with the airline is managed directly from the United Kingdom. We have a more extensive presence in Mainland China, where all the major airline groups operate Rolls-Royce engines and where our marine and energy businesses have significant activity. We also purchase a wide range of parts and materials in China and have a JV in Xi'an, Shaanxi, which manufactures turbine components. We have 230 direct employees and another 320 employees in the Xi'an JV. Mainland China business is growing rapidly from a lower base, whereas our Hong Kong business is more mature and focused on one major customer. That said, Hong Kong remains a significant hub for regional aviation, and Cathay Pacific will remain one of our most important customers. Cathay Pacific, with its ownership of Dragonair [Hong Kong Dragon Airlines Ltd.], will expand its presence in China and throughout Asia. Their partnership with Air China Ltd. should also be an important source of growth for them. Richard Margolis, Regional Director, Northeast Asia, Rolls-Royce International Ltd. In 2003, Richard Margolis joined Rolls-Royce International Ltd. in Beijing, where he covers Greater China and South Korea. Margolis lived and worked in Hong Kong from 1981 to 2003. After a 14-year Diplomatic Service career during which he was posted in Beijing, Paris, and Hong Kong, Margolis moved to the private sector in Hong Kong in 1986. From 1995 to 2001, he worked at Merrill Lynch in various capacities, including as head of Strategy and Planning for Asia Pacific. During his five years as deputy political advisor to the governor of Hong Kong (1981–86), Margolis was closely involved with the United Kingdom-China negotiations on Hong Kong's future. Further Reading Hong Kong or Shanghai? Whither Hong Kong? The Demise of the Hong Kong Dollar Peg Can the Pearl River Delta Region Still Compete? Click here for copyright permissions Copyright 2007 US-China Business Council Top of Page Table of Contents
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Interview

Hong Kong 10 Years On

Ten years after the return of Hong Kong to China, the city highlights its advantages in the face of increased competition from the Mainland

Richard Margolis, Regional Director, Northeast Asia, Rolls-Royce International Ltd.

Further Reading