Economic Integration: A Win-Win Blueprint for All of China

Paul Cavey (Senior Economist, The Economist Intelligence Unit, Hong Kong)

(This article originally appeared in the July 14, 2003 issue of South China Morning Post in Hong Kong and is reproduced here with permission from the publisher)

Nowhere is the effect of mainland China's economic awakening being felt as strongly as in Taiwan and Hong Kong. Geographical proximity, historical connections and ethnic composition position the two former tiger economies uniquely on the edge of the dragon's lair.

Their fears are, however, misplaced. If the development of stronger economic links with the mainland is combined with domestic reforms, the mainland will continue to be more economic opportunity than threat to both.

Even before the outbreak of Sars, the economies of Taiwan and Hong Kong were looking their weakest in a generation. Taiwan suffered a searing recession in 2001 and unemployment remains above 5 per cent. Hong Kong's downturn was triggered by the 1997-1998 Asian financial crisis, which led to the crash of the stock and property markets.

That event was followed by two recessions, an increase in unemployment from 2.2 per cent to more than 7 per cent, and four full years of falling consumer prices.

To many in Taiwan and Hong Kong, it is no coincidence that these severe domestic problems have emerged just as both have become more closely entwined with an increasingly strong mainland economy. Indeed, there is a palpable fear that the current downturns are directly caused by their changing relationship.

Newspapers in Taiwan talk of an exodus of investment and people to the other side of the strait. Perhaps 400,000 people from Taiwan - almost 2 per cent of the domestic population - now live in the Shanghai area alone.

To the south, meanwhile, figures showing increasing throughput in Shenzhen's ports are eagerly seized upon as evidence of Hong Kong's growing irrelevance as a transit point for mainland trade, while the decision of any foreign bank to establish an office in Shanghai is regarded as another nail in the coffin of Hong Kong's financial relevance.

But these worries are overdone. The macroeconomic problems being experienced in both Taiwan and Hong Kong are due less to mainland-related, structural factors than to the cyclical downturn of the global economy in 2001-2002, aggravated by domestic political problems. Taiwan has also had to deal with a poorly performing banking sector, while Hong Kong has struggled to recover from the bursting of a property market bubble.

At the same time, there has been no simple outflow of corporate activity from either of the former tiger economies. Rather, for both Taiwan's manufacturing industry and Hong Kong's service sector, the picture is more one of a developing division of labour, in which some lower-end processes move out, while higher-end ones remain and, more often than not, expand. Contrary to the fears of some, both Taiwan and Hong Kong have sophisticated industry clusters - manufacturing of IT hardware in one, services in the other - that will not be easily replicated on the mainland.

Prosperity is not, however, pre-ordained. Take Taiwan. The island is well-placed to be a major centre not just for the manufacture of information technology hardware, but for its development. However, without being more open to exchanges of people, resources and information with the mainland, it will be difficult for the island to achieve this destiny. At the very least, removing the restrictions would allow the island's service sector, crippled by the limits on cross-strait economic ties, to become an alternative engine of growth.

Hong Kong has not been hobbled by the same kind of restrictions. It is largely because of openness with the mainland that the special administrative region has evolved over the past 20 years from a world centre for low-end manufacturing to a global provider of high-end services. But Hong Kong's interflow of goods and people has been less free. This did not matter when Hong Kong was the only city in China that offered an international-style airport, port and quality of life. But with the mainland's physical and policy infrastructure improving rapidly, this has changed.

Closer links with the mainland on their own are, however, insufficient to ensure continued prosperity.

Taiwan and Hong Kong will profit not from being part of the mainland's economy, but rather from being distinct and well-run entities with especially strong links to the mainland. Taiwan's government, for example, must implement much-needed improvements in the country's basic physical and regulatory structure.

Officials in Hong Kong, on the other hand, need to take on the interest groups that have prevented the territory's economy from being as competitive as is often claimed.

This two-pronged policy prescription presents difficulties for both Taiwan and Hong Kong. There is already concern in Taiwan about the leverage over the island's political future that the central government may gain through the island's growing investment in, and trade with, the mainland. But the alternative - economic irrelevance as China's economy becomes ever stronger - is hardly a palatable choice either.

Further integration does worry some in Hong Kong as well - property owners and developers fear closer cross-boundary links will cause prospective homeowners to flee the territory in favour of cheaper opportunities in Shenzhen. If closer integration is combined with domestic reforms, however, Hong Kong will remain in demand. Taiwan's president, Chen Shui-bian, has said direct links are no cure-all for the island's economy. This is undoubtedly true, and is equally valid for Hong Kong. But with the right domestic reforms, both former tiger economies have much to gain from the emergence of China.