Do Chinese prefer less freedom

Hong Kong

Heribert Dieter

To person

is a researcher at the Science and Politics Foundation in Berlin and is currently visiting professor at the Asia Global Institute at the University of Hong Kong. [email protected]

The ongoing protests in Hong Kong have permanently changed the city. Until the summer of 2019, Hong Kong was a rather apolitical city, in which economic development was in the foreground. There have been demonstrations against the government in previous years, but both the number of participants and the duration of the unrest have reached new levels. For the Chinese central government, the development is extremely inconvenient.

In addition to the conflict with the USA and the economic difficulties of his country, President Xi Jinping is now also struggling with ongoing protests in the Hong Kong Special Administrative Region. Many observers expected the Chinese army to intervene at an early stage and thus a repetition of the bloody crackdown on protests such as in 1989 on Tian’anmen Square. While no one can rule out such a measure, it appears extremely unlikely. The reason for this is the outstanding importance of the Hong Kong financial center for the Chinese economy. If Hong Kong were to lose its special status, the Chinese Communist Party would have to cope with enormous economic turmoil that could call its own rule into question.

But just as important as the question of the consequences of the possible termination of Hong Kong's special status is the question of why the protests have not lost any of their force even after more than six months. It is less about the comparatively small number of violent fighters and more about the continued civil support of the protests. Why are the residents of Hong Kong so dissatisfied with the government, despite comparatively high incomes, long life expectancy and some considerable social benefits, that they refused to support it not only on the street but also in the local elections on November 24, 2019? Why is the city not calming down? Ultimately, won't the unrest also endanger Hong Kong as a business location?

Hong Kong's advantages

Hong Kong's importance for China is based on two functions: On the one hand, Hong Kong is the only Chinese financial center that has no restrictions on the movement of capital and is therefore structurally different from the mainland. On the other hand, Hong Kong has an important port through which considerable exports from the mainland are processed, also for tax reasons.

Hong Kong's economic constitution is a legacy of colonial times. The Crown Colony was also useful for Great Britain because a very liberal economic policy could be implemented there regardless of social concerns. This situation has not changed since the return of Hong Kong to the People's Republic of China in 1997. Hong Kong continues to be number 1 on the Economic Freedom Index compiled by the US Heritage Foundation. [1] So Hong Kong is one of the most attractive locations in the world to do business and make a profit. However, this policy also has serious disadvantages for the residents of the city, which will be examined more closely.

Today Hong Kong is a special case from Beijing's point of view, but it gives China many advantages. The formula "one country, two systems" is not limited to the political dimension, but also applies to the financial system. There is no financial center in China comparable to Hong Kong. A number of factors mean that the Special Administrative Region is indispensable for the People's Republic.

The main difference between the mainland and Hong Kong financial centers concerns the movement of capital. While the export of capital on the mainland is subject to strict rules, capital exports and imports in Hong Kong are unrestricted. This is an advantage that can hardly be overestimated. Especially in the phase of increasing control of foreign companies in the kingdom of Xi Jinping, it is beneficial for companies to be able to export capital without government requirements. This is why more than 2,200 European and 1,344 American companies have their regional headquarters in Hong Kong rather than Shenzhen or Shanghai. [2]

However, it is by no means only foreign companies that benefit from the advantages of the financial center. Many mainland companies use Hong Kong to borrow in US dollars, euros or yen. If this possibility were not available, these companies would be forced to borrow in local currency. Although this is basically possible, it has two disadvantages. On the one hand, much higher interest rates have to be paid for renminbi loans; on the other hand, the availability of loans, especially for private companies on the mainland, is severely limited.

For Chinese mainland companies, Hong Kong is by far the most important financial center for corporate bond issuance. In the SAR, firms can sell longer-term bonds than on the mainland, and they can use these bond issues to earn dollars, euros, or yen, which they can use to fund takeovers in OECD countries. [3]

Companies also value Hong Kong's exchange rate regime. Since 1983 the Hong Kong dollar (HKD) has been in one currency board linked to the US dollar. This exchange rate regime, originally developed by Great Britain to organize economic relations with its Gold Coast colony, today's Ghana, ensures stability. The Hong Kong Monetary Authority pegged the local currency to the US dollar on October 17, 1983 and initially set the exchange rate at HKD 7.8 per US dollar. The HKD is now allowed to fluctuate within a narrow range, from 7.75 to 7.85 HKD per US dollar.

In order for this exchange rate regime to be credible, the Monetary Authority needs high reserves to be able to fend off speculative attacks on the HKD. This is ensured: Hong Kong's currency reserves currently amount to just under 4200 billion HKD or around 460 billion euros, making them the second highest currency reserves in the world after those of Switzerland on a per capita basis. Hong Kong's currency reserves are almost as high as those of India, which is home to 180 times as many people. In absolute terms, the currency reserves are higher than those of South Korea, Brazil and Mexico, all of which are significantly larger economies.

So far, this regime has survived severe economic turbulence, especially the Asian crisis of 1997/98 and the global financial crisis of 2008/09, without upheaval. The last speculative attack on the HKD exchange rate occurred during the 1997 Asian Crisis, but the monetary authority was able to fend off this attack with HKD 118 billion. [4] A stable exchange rate is of great benefit to companies because they do not need to hedge against fluctuations in exchange rates.

Foreign lenders or buyers of corporate bonds prefer Hong Kong not only because of the unlimited export of capital, but also because, unlike on the mainland, the legal system is at least so far independent. The legal system is based on the Anglo-Welsh common law. Unlike in Beijing or Shenzhen, the judicial system in Hong Kong is a guarantee of freedom and property rights and also offers protection against arbitrariness by the state.

In the debate about the status of Hong Kong, the idea is repeatedly expressed that the high-tech metropolis on the other side of the Pearl River, Shenzhen, could replace Hong Kong as a financial center. This is in line with the decision of the Chinese central bank, from August 30, 2019, to allow not only banks to convert the local currency into other currencies without prior control. This is a small softening of China's capital movement restrictions, but the road to removing the restrictions remains very long. [5]

A similar experiment in Shanghai, the Shanghai Pilot Free Trade Zone, started in 2013 with great expectations, but they were not fulfilled. Many banks left the free trade zone again because the announced lifting of the capital movement restrictions was not implemented. [6] It is simply not possible to establish a financial center within an economy without restrictions on the movement of capital without liberalizing capital movements for the whole country. Beijing is shying away from this step because it could lead to disorderly capital outflows and turbulence in the currency markets.

The most important factor in favor of Hong Kong, however, is the staff of international banks. It is hard to imagine that highly qualified financial market specialists would leave Hong Kong to move to Shenzhen or Shanghai. Before the People's Republic of China under the leadership of Xi Jinping developed into a state that severely restricts the freedom of individuals, such a scenario may have been conceivable, but today hardly a banker would be willing to move to the mainland.

However, Hong Kong is not only a financial center, it also has one of the largest ports in the world. The Hong Kong port is still the largest container port for southern China, the economic heartland of China. The low taxes in Hong Kong mean that the handling of goods in Hong Kong serves to minimize the tax burden. Mainland firms export goods manufactured there at cost to their subsidiaries in Hong Kong. From there it is exported to other countries, while the profits are booked in Hong Kong. This is lucrative because the Hong Kong government taxes corporate profits at a maximum of 16.5 percent. [7]

Connection to the mainland?

Under international law, the Hong Kong Special Administrative Region is without a doubt a part of the People's Republic of China. If General Secretary Xi Jinping were to set the People's Liberation Army in motion and end Hong Kong's special status not in 2047 but in 2020, that would not be a violation of international law. A quick connection to Hong Kong would nevertheless have serious consequences for the whole of China and therefore appears unlikely. Competing economic centers, both Chinese and other Asian financial centers, such as Singapore, cannot replace Hong Kong in the short or medium term. Asia's most cosmopolitan city is annoying from the Communist Party's point of view, but it is still a gem that the People's Republic cannot and probably does not want to do without.

The violent protests of the population have not yet led to the deployment of the army. If tanks were sent to Hong Kong, the special status of the city would be irretrievably destroyed. China would lose its window on the world and face serious economic consequences. Above all, the USA would use a crackdown on the protest movement as an opportunity to end Hong Kong's special role. Such a step would be extremely risky for CP Chairman Xi. This would give the already weakening domestic economy a further shock. And it is by no means ruled out that an army invasion would not trigger a chain reaction that could result in a major upheaval in China.

The reasons for this vulnerability of China are quickly stated. The Chinese economy is over-indebted and at the end of 2018 had total debt (excluding the financial sector) of over 300 percent of economic output. As long as there is no panic on the financial markets, such a level of debt is manageable. At the same time, a huge real estate price bubble has arisen in China. The value of all residential real estate is estimated at $ 65,000 billion. Two-thirds of bank loans in China are residential real estate collateral. However, 20 percent of the apartments in China are empty. This fragile constellation can get out of balance at any time, and the CP leadership is well aware of this.

This is one of the reasons why Beijing's line has so far been hesitant and waiting with regard to Hong Kong. On the other hand, the US is aware of China's vulnerability and is exhausting its hand. The US government is putting pressure on China right now because it can currently afford this conflict better than China. However, almost 30 years ago, American politicians took precautions in the event of a change in the status of Hong Kong and even passed statutory regulations on this.

Hong Kong and the USA

On October 5, 1992, American President George H.W. Bush passed the Hong Kong Special Status Act. Well before Hong Kong was returned to China, the US Congress campaigned for the city's special rights to be safeguarded. On the one hand, this applies to the trade in goods. The law states that the US should respect Hong Kong's status as a separate customs area. In surprising detail, the law states that the United States should continue to grant Hong Kong Most Favored Nation status and recognize certificates of origin for manufactured goods issued by the Hong Kong authorities. Hong Kong is granted access to technologies that are restricted from being exported to the People's Republic.

In addition to the trade in goods, Hong Kong's status as a financial center is described in detail in the law. The US dollar should be able to be freely traded there. Finally, the Hong Kong Policy Act mentions that companies should be encouraged to continue operating in Hong Kong. The law also specifies political goals that the US government has no direct influence on. Whether or not companies operate in Hong Kong is a decision of those companies, not the government. Nevertheless, the signaling effect of the law of the time is remarkable.

The US has not interfered directly in China's internal affairs, but it has made it clear that it is unwilling to continue to grant preferential treatment to the Special Administrative Region if Hong Kong's special status ceases to exist. The Hong Kong Policy Act explicitly empowers the President to end preferential treatment for Hong Kong if he finds that Hong Kong is not sufficiently autonomous. In November 2019, the provisions of the law were upheld by the Hong Kong Human Rights and Democracy Act. What is remarkable about the new law is not so much the content as the fact that it was passed unanimously in both the House of Representatives and the Senate. In a phase of strong polarization in American politics, the attitude towards China is perhaps the only connecting link in American politics and society. [8]

However, in 1992 the MPs probably had no idea what special explosive power the law would have in 2019. Due to the trade war between the USA and China, the importance of Hong Kong has increased, not decreased. Exports from Hong Kong to the USA are exempt from Donald Trump's punitive tariffs. Treating Hong Kong exports like mainland China exports would close a loophole for Chinese exports. [9] It is estimated that 98 percent of Hong Kong's exports to the US could be affected by punitive tariffs if the city loses its special status. [10]

Hong Kong therefore fulfills an important function for the People's Republic of China, especially in times of ongoing trade tensions with the USA. At the same time, of course, it is also true that Hong Kong is dependent on the economic ties with the People's Republic. The Special Administrative Region is so prosperous not least because it provides important trade and financial services for China. If the unrest in Hong Kong continues for a long time, this could also lead to a massive weakening of the location.

But how realistic is it that the protests will abate like in 2014? The occupation of the inner city (Occupy Central) ended after 77 days. The resentment against the city government did not disappear with the end of the protests. Hong Kong's people were and are upset not only because of the threat to their political freedom, but also because of the difficult social situation in which they find themselves.

Social background of the protests

The bitterness of the protesters in Hong Kong is exacerbated by their difficult economic and social situation. In Hong Kong, a large part of the population lives in difficult conditions. The Hong Kong government and the Chinese Communist Party have ignored these issues for too long and now face an angry people who oppose reconciliation and the return to normal

This is a surprising finding because Hong Kong is a wealthy city. In 2018, annual per capita income was $ 50,300, up 64.5 percent from 2010 when per capita income was $ 33,620. [11] At 84.7 years (2017), Hong Kong residents have the highest life expectancy in the world. The city has world-class public transport systems that are significantly better than many OECD countries, including Germany. The health system is based on the UK system and provides citizens with basic medical treatments free of charge.

But the Hong Kong people are dissatisfied and were so before the mass protests. In the 2018 United Nations Happiness Report, Hong Kong ranks 76th and thus a significantly lower ranking than comparable economies such as Taiwan (25th) or Singapore (34). [12]

An important cause of dissatisfaction is the precarious housing situation. For more than a decade, Hong Kong has had one of the most expensive real estate markets in the world. Citizens pay a lot of money for tiny apartments. The average living space per person is only 15 square meters, about the area of ​​a standard shipping container. The Singaporeans have twice as much living space per capita. Buying an apartment requires extreme hardship and even then is inaccessible to many Hong Kong citizens.

The limited supply of housing is the result of increased demand and scarce supply. Hong Kong's population has increased more than twelve-fold since 1945: from 600,000 to 7.4 million people. But the supply of living space was not keeping pace. The simplest solution would be to build a lot of new homes, but this is proving difficult, mainly due to outdated regulations for the provision of building land. However, Hong Kong also has many nature reserves that are not allowed to be built on and whose conversion to building land would meet with considerable resistance.

Another reason for the great dissatisfaction of the Hong Kong population is the high level of inequality in income distribution. The Gini coefficient, which measures the inequality of distributions, household income before taxes and social contributions in 2016 was 0.539, higher than in all OECD countries. Even after taxes and transfers, the Gini coefficient was 0.473 and thus significantly higher than in Singapore (0.356), the USA (0.391) or Australia (0.337), for example. [13] In Northern European countries including Germany this value is below 0.3.

The cause of the great inequality is the tax system adopted by the British. Both corporate profit taxes and income taxes were and are low. There is no sales or value added tax. Dividends are tax-free. Hong Kong's status as an attractive financial center is strengthened by these fiscal policies, but these policies lead to inequality. An example: The five richest Hong Kong residents received tax-free dividends of HKD 23.6 billion in 2016/17, which is around EUR 2.7 billion. [14] Not surprisingly, many Hong Kong citizens are outraged about this.

What's next?

The ongoing unrest has transformed Hong Kong and its society. A return to the comparatively apolitical attitude of many Hong Kong residents in the past seems impossible today. People are constantly discussing political issues. A new identity is also developing in the process. The Hong Kong people are increasingly separating themselves from the mainland Chinese. Growing nationalism can also be observed there. This development can be found in the formula "One Country, Two Nationalisms". [15] It seems difficult to expect a balance between the interests of the majority of Hong Kong people and those of the Communist Party and its supporters.

The main reason the situation remains hardened is that the government of the Special Administrative Region under Carrie Lam and its police force are exacerbating the crisis and making no offers to the protesters. Within a short period of time, the population has developed strong doubts about Hong Kong's institutions. Above all, trust in the police has fallen sharply in recent months. In a survey by the Center for Communication and Public Opinion Survey at the Chinese University of Hong Kong in October 2019, 51.5 percent of respondents said they had no confidence in the police, compared with just 6.5 percent in May and June. [16] These polls were completed before a police officer shot an unarmed man in the abdomen on November 11th. The 21-year-old young man lost a kidney and part of his liver. While still in the hospital, he was charged with participating in an unauthorized demonstration. The Sagittarius is not suspended, but on sick leave.

It is unlikely that the government and police will approach the protesters. The first act of the newly appointed police chief in November 2019 was to change the motto of the Hong Kong police force. Out of "pride and care" (pride and care) became "honor, duty and loyalty" (honor, duty and loyalty). [17] Beijing's handwriting can be clearly seen here.

From today's point of view, three scenarios appear possible: firstly, a quick annexation of Hong Kong to mainland China, secondly, persistent unrest without political consequences, and thirdly, a settlement of the conflict.

A quick connection, i.e. the end of Hong Kong's special status before 2047, is unlikely. As described, the economic risks are too great.

The second variant seems more likely. An exhaustion competition develops. Who can hold out the conflict longer? So far, it appears that the Lam administration is pursuing this strategy. The Hong Kong government's administrative director, Matthew Cheung, said in parliament on November 13, 2019 that he did not know why Hong Kong's citizens were so angry. The government makes no offers to talk and appears paralyzed and incompetent. In favor of the government, it must be mentioned that it also has no negotiating partner. The protest movement has no leader, which is also a consequence of the 2014 protests: At that time, every person was arrested with a megaphone.

That leaves the third variant: at least two conditions would have to be met for a peaceful settlement of the protests. Carrie Lam would have to resign and an international commission of experts would have to be commissioned to investigate the police violence against the demonstrators. Historical models for this process exist. When a law was to be passed in 2003 that would provide for higher penalties for certain acts, such as high treason, 500,000 Hong Kong residents took to the streets. The then Prime Minister Tung Chee-hwa withdrew the law and resigned from office.

This variant would in principle still be possible today, but it is also unlikely because it would require the approval of the CP General Secretary Xi Jinping. So far, Xi has not indicated that he is willing to make concessions, probably also because he fears the signaling effect on other cities and regions of the People's Republic.

Of course, completely different, radical variants are also conceivable: Beijing could extend Hong Kong's special status until 2097, allow free elections and begin transforming China into a federal system. As long as Xi Jinping is in power, such considerations are pure utopia. He relies on strengthening control by the Communist Party, not on the liberalization of Chinese society. Xi will still have to rely on the stubborn gem Hong Kong for the foreseeable future, albeit reluctantly.