Journal Issue

United Kingdom-Hong Kong: Selected Issues

International Monetary Fund
Published Date:
July 1997
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I. Introduction and Overview

124. Over the past fifteen years, Hong Kong’s economic performance has been exceptionally strong. Real GDP growth has averaged almost 7 percent a year, and per capita GDP has increased fourfold. Following the Start of reform and opening up of China in the late 1970s, the Hong Kong economy has become increasingly linked through trade and investment to the Chinese economy. As Hong Kong manufacturers have shifted operations to Southern China, the importance of manufacturing activity and domestic merchandise exports in Hong Kong has declined and Hong Kong has emerged as a mature, services-based economy. While the trend growth rate of GDP has eased slightly, the cyclical variability of output has diminished substantially.

II. Economic Integration With China

125. Since the late 1970s, when China began its program of reform and opening up, trade and investment links between the Hong Kong and Chinese economies have strengthened dramatically. Hong Kong manufacturers have shifted labor-intensive operations to southern China, where labor and facility costs were up to 15 times and 5–10 times lower, respectively, than in Hong Kong. As a result, the importance of manufacturing activity in Hong Kong declined. Correspondingly, Hong Kong’s services sectors expanded rapidly, in part to support increased economic activity in China and partly as Hong Kong’s importance as an international financial center grew.

A. Economic Links between Hong Kong and China

126. As the Hong Kong and Chinese economies have become increasingly integrated, links between the two economies in trade, investment, and financial flows have strengthened. Indeed, Hong Kong, because of its locational advantage and status as an international financial center, has served as the financial gateway to China.

Trade links

127. Over the past 15 years, bilateral trade flows between China and Hong Kong have become increasingly important. Merchandise exports from China to Hong Kong rose from $4 billion in 1980 to $70 billion in 1995. As a proportion of total Chinese merchandise exports, the share of exports to Hong Kong rose from 22 percent to 47 percent. For Hong Kong, imports from China accounted for 36 percent of total imports in 1995, compared with 20 percent in 1980. However, the share of Chinese exports in Hong Kong’s retained imports has been only 6 percent in recent years.

128. Hong Kong’s exports destined to China have also risen steadily over the past 15 years, from $1 billion in 1980 to $58 billion in 1995. For China, the share of imports coming from Hong Kong in total imports rose from 7 percent in 1980 to 44 percent in 1995, while the proportion of exports to China in Hong Kong’s total exports rose from 6 percent to 33 percent. The share of Hong Kong’s domestic exports going to China rose from 2 percent of total imports in 1980 to 27 percent in 1995.

129. A large proportion of the trade between Hong Kong and China is in raw materials or intermediate goods for use in outward Processing operations by Chinese enterprises—including local enterprises, joint ventures, or foreign-funded enterprises—that subcontract all or part of the production processes of Hong Kong Companies. In 1995, outward processing trade accounted for 69 percent and 77 percent of Hong Kong’s domestic exports and reexports, respectively, and 74 percent of Hong Kong’s imports.

130. The increase in bilateral trade has, to a large extent, reflected Hong Kong’s emergence as a major entrepot for trade between China and the rest of the world and the rising importance of reexports in Hong Kong’s total international trade. Of all Hong Kong’s reexports in 1995, almost 60 percent originated in China while over 30 percent were destined to China. By way of comparison, less than 45 percent of reexports in 1980 were China-related.

Investment links

131. The relocation of production facilities from Hong Kong to Southern China has been accompanied by massive flows of foreign direct investment. As of 1995, Hong Kong’s direct investment in China amounted to $80 billion, representing over 60 percent of total realized foreign direct investment in China.42 There are presently over 25,000 Hong Kong firms operating in China, employing 4–5 million workers.

132. China has also invested heavily in Hong Kong and is presently the third largest source of inward direct investment. By end-1994, there were about 1,700 China-related enterprises operating in Hong Kong, and the cumulative value of Chinese investment in Hong Kong was about $25 billion by 1995. Investment from China has covered a wide range of activities, including import and export trade, Wholesale and retail services, banking and financial services, transportation, warehouses, hotels, and manufacturing operations. In addition, several major China-related Companies have equity stakes in large infrastructure projects in Hong Kong, and substantial Chinese investment has taken place in Hong Kong’s property market. For example, China’s investment in the property market in 1993 is estimated at $2 billion, of which 60–70 percent was from individuals, 20–30 percent from China-related enterprises, and 10 percent from the Chinese Government.

Financial links

133. Banking and financial links between Hong Kong and China have developed. The Bank of China group has become, in recent years, Hong Kong’s second largest banking group and, since 1994, has been one of the three note-issuing banks for the Hong Kong dollar. Three of Hong Kong’s banks—the Standard Chartered Bank, the Hongkong Bank Group, and the Bank of East Asia—are among the most active foreign banks in China. It is estimated that about one fourth of the Hong Kong dollar currency circulates in China, representing the equivalent of about 3 percent of China’s currency in circulation.

134. Since the Capital market in China is relatively small, Chinese enterprises have increasingly sought Capital abroad. Initially, some Chinese enterprises entered the Hong Kong stock market by purchasing listed Companies to raise equity finance in Hong Kong. Since 1993, when the listing of Chinese Companies on the Stock Exchange of Hong Kong was allowed, 22 Companies have been listed, raising a total of $2.6 billion at launch. Hong Kong has also been a major funding center for syndicated loans to Chinese enterprises. As of end-September 1996, Hong Kong banks’ Claims on banks and nonbanks in China amounted to $44 billion. At the same time, liabilities of the Hong Kong banking system to Chinese entities were $35 billion.

135. Despite Hong Kong’s importance as a financial center for China, Chinese enterprises occupy only a small share in the banking and financial business conducted in Hong Kong. Claims on Chinese entities represent 7 percent of total external claims of the Hong Kong banking system, while liabilities to banks and nonbanks in China account for 6 percent of total external liabilities.

B. Implications of Economic Integration

136. As the degree of economic integration between the two economies has increased through stronger production, investment, trade, and financial links, the level of Overall economic activity in Hong Kong has tended to move more closely with economic activity in China. Indeed, the degree of correlation between cyclical variations in economic output in Hong Kong and China rose sharply as integration progressed.

137. To measure the correlation between economic activity in the two economies, quarterly data on Hong Kong’s GDP and China’s industrial production were decomposed into trend and cyclical components.43 A measure of the relation between business cycles in Hong Kong and China may then be obtained by computing the correlation between the cyclical components of both series. For every quarter starting in late 1986, such correlations for the previous five years were calculated.

138. The results of the empirical exercise indicate that the correlation did indeed intensify during the 1980s (Chart 1). In the first half of the 1980s, there was virtually no correlation between the cyclical components of Hong Kong’s GDP and China’s industrial production, as suggested by an estimated correlation coefficient of about zero for the last quarter of 1986. Through the second half of the 1980s, however, the relation between the two economies appears to have strengthened rapidly, as indicated by the sharp rise in the estimated correlation coefficient to about 0.9 by 1992. Since that time, while the estimated correlation has declined somewhat, the correlation coefficient remains quite high (between 0.6 and 0.8 during 1995–96).


Source: Hong Kong Monthly Digest of Statistics; IMF International Financial Statistics; and staff estimates.

III. Economic Structure

139. Hong Kong’s economic integration with China has brought with it a dramatic change in the structure of Hong Kong’s economy. As labor-intensive manufacturing production has relocated to China, supporting service industries have assumed importance in Hong Kong. As a result, Hong Kong has emerged in the 1990s as a mature, services-based economy, with substantial changes having taken place in the structure of output and trade.

A. Output Structure

140. In the 1980s, as Hong Kong manufacturers shifted production operations to Southern China and export activity in China picked up, supporting services industries in Hong Kong, particularly in the trade and financial services sectors, expanded. The emergence of Hong Kong as an major international financial sector during this period further boosted the growth of the services sector. Hence, by the mid 1990s, a dramatic shift in Hong Kong’s economic structure had taken place. The Hong Kong economy had transformed from one with a large manufacturing sector to one that is largely services-based.

141. The structural change was reflected in the relative shares of manufacturing and services in both employment as well as value-added (Chart 2). In terms of employment, the manufacturing sector’s share in total private sector employment declined from almost one half in 1980 to below 15 percent in 1996, while the share of trade and financial services rose from under one third to about 60 percent. As a share of overall GDP, the manufacturing sector accounted for almost one fourth in 1980, compared with less than 10 percent in 1994, the most recent year for which data on GDP by type of economic activity are available. The share of the services sector, which was almost two thirds in 1980, increased to almost 85 percent in 1994, while the share of trade and financial services rose from 43 percent to 53 percent.


Source: Hong Kong Annual Digest of Statistics.

142. This rapid transformation of the economy was achieved without serious disruption in the labor market. Wages generally adjusted with considerable flexibility to changes in market conditions. While the initial structural shift and heightened Immigration from China led to temporarily higher unemployment, there was actually a shortage of labor through most of the 1980s and 1990s, and the unemployment rate remained around 2 percent for much of the period (Chart 3). Substantial gains in labor productivity were also achieved, and Hong Kong ranked well ahead of the industrial countries in terms of total factor productivity growth (Chart 4).44


Source: Hong Kong Monthly Digest of Statistics.


Sources: OECD International Sectoral Database; Economic Planning and Advisory Council estimates; HKMA Quarterly Bulletin (August 1995); Hong Kong Annual Digest of Statistics; and staff estimates.

1/ Data for Hong Kong, Korea, and Singapore are for 1965–90.

B. Export Structure

143. Accompanying the change in the structure of output has been a significant shift in the structure of exports. Exports of goods and services have risen steadily—from about 70 percent of GDP in constant prices in the early 1980s to almost 200 percent of GDP in recent years (Chart 5).45 The composition of exports, however, has undergone dramatic change. As export-oriented manufacturing production has relocated to China, Hong Kong’s manufacturing exports have declined while reexports—goods that are imported, processed, and reexported—and exports of services have risen.



Sources: Hong Kong Monthly Digest of Statistics; and staff estimates.

1/ The trends were estimated by applying the Hodrick-Prescott filter to seasonally adjusted export data.

144. Since the late 1980s, there has been a trend decline in domestic merchandise exports, both in absolute terms and relative to GDP—from about 40 percent in 1988 to 25 percent in 1996. By contrast, the trend reexport to GDP ratio, in constant prices, has risen from under 20 percent in the early 1980s to 140 percent in 1996, accelerating markedly in the late 1980s. Exports of services have also risen, and presently amount to almost 30 percent of GDP.

145. Reflecting strong external demand, the net external balance for goods and services improved in the 1980s, with the net external surplus amounting to 10 percent of GDP (in constant prices) in 1988–89 (Chart 6). Since that time, however, a consumption boom in the early 1990s and the surge in infrastructure investment in 1993–96 associated with the new airport boosted imports and resulted in a deterioration of the balance between domestic merchandise exports and retained merchandise imports.


(In percent of GDP; 1990 prices)

Sources: Hong Kong Monthly Digest of Statistics; and staff estimates.

1/ Trends were estimated by applying the Hodrick-Prescott filter to seasonally-adjusted data.

2/ Domestic merchandise exports less retained merchandise imports.

146. Partly offsetting the deterioration in the net domestic merchandise trade balance has been a rise in net services exports, particularly since 1991. This has been related, in large part, to the shift in manufacturing activity from Hong Kong to China, and the resulting growth of supporting services in Hong Kong. In addition, the volume of net reexport activity has risen—again on account of increased export activity in China.

IV. Business Cycles

147. The structural transformation of the Hong Kong economy over the past fifteen years has been associated with a reduction in the cyclical variability of output. As Hong Kong has become a more services-based economy, its trend rate of growth has declined somewhat, but has remained well above the growth rates of the industrial countries.

148. The estimated trend growth rate of the Hong Kong economy, has eased from about 9 percent in the early 1980s to about 5–5½ percent in 1996 (Chart 7).46 Several cycles of growth have been experienced since the early 1980s. A sharp downturn in economic activity in 1984–85 was followed by a strong recovery; a more moderate slowdown in the early 1990s was followed by a moderate pickup in 1993–94. Finally, activity weakened in 1994–95, and a recovery appears to be underway in 1996–97.


Sources: Census and Statistics Department, Hong Kong Monthly Digest of Statistics; and staff estimates.

1/ Trends were estimated by applying the Hodrick-Prescott filter to seasonally-adjusted data.

149. The amplitude of Hong Kong’s business cycles has declined markedly in the 1990s. While output deviated by as much as 8 percent from the trend in the mid 1980s, cyclical deviations of output in the 1990s were less than 2 percent from the estimated trend. This outcome coincided with the transformation of the economy from one that had a substantial manufacturing sector in the 1980s to one that is now largely services-based. Indeed, the shift in the relative importance of services exports, which have fluctuated by 1–2 percentage points of GDP around the trend, in place of merchandise exports, which varied by as much as 10 percentage points of GDP around trend, contributed to the reduction in the volatility of overall economic output.

150. During the 1980s, cyclical fluctuations in domestic demand were closely reflected in cyclical variations in GDP (Chart 8). In the 1990s, domestic demand has been much more volatile around its trend than overall GDP. As domestic demand fluctuated, so too did imports—which account for a sizable portion of domestic absorption. Indeed, the import content of the consumption boom and the surge in airport-related investment in the 1990s was high. Hence, cyclical variations in the net external balance, reflecting changes in import patterns, partly offset fluctuations in domestic demand.


Sources: Census and Statistics Department, Hong Kong Monthly Digest of Statistics; and staff estimates.

151. Coinciding with the increased volatility of domestic demand in the 1990s was a decline in the contribution of exports to overall GDP growth. As a result, while movements in the external balance had a dampening effect on the volatility of domestic demand, the importance of changes in domestic demand in terms of contribution to overall GDP growth increased.

152. Fluctuations in inflation have also tended to stabilize in the 1990s (Chart 9). Except for a brief period in 1990–91—when prices accelerated partly in response labor market pressures associated with a pickup in emigration—movements in inflation have generally been procyclical, suggesting that demand factors have played an important role in determining inflation outcomes.


Sources: Census and Statistics Department, Hong Kong Monthly Digest of Statistics; and staff estimates.


    Hawkins, John, “The Best of Times, The Worst of Times: Developments in Productivity,” HKMA Quarterly Bulletin (Hong Kong: Hong Kong Monetary Authority, August1995), pp. 11–21.

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    Lee, Joseph Siu-Lun, and HowardDavies, “Transforming Hong Kong: from Manufacturing to Services,” in HowardDavies (ed.) China Business: Context and Issues, (Hong Kong: Longman Asia Limited, 1995), pp. 22–36.

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    Young, Alwyn, “A Tale of Two Cities: Factor Accumulation and Technical Change in Hong Kong and Singapore,” NBER Macroeconomics Annual (Cambridge, MA: The MIT Press, 1992), pp. 13–54.

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This paper was prepared by Aasim Husain.


This includes foreign direct investment in China by foreign-owned firms incorporated in Hong Kong. Disaggregated data on Hong Kong’s foreign investment by firms’ country of ownership are not available.


Trends were fitted by applying the Hodrick-Prescott filter to both data series. Cyclical components of the series were calculated as the difference between the actual, seasonally-adjusted data and the fitted trend. In view of the increasing importance of net factor income from abroad for Hong Kong, GNP data series should ideally have been used for both economies. However, quarterly GNP data are unavailable for Hong Kong, and available quarterly GNP and GDP data series for China go back only to the late 1980s.


Total factor productivity growth was estimated at 4.3 percent a year during 1965-90 by Hawkins (1995) and 2.7 percent a year during 1971-90 by Young (1992). Total factor productivity growth in most industrial countries has been in the range of ½-2 percent.


Owing to the steady shift in the relative price structure toward higher nontradeables prices, export to GDP ratios in current prices differ markedly from the ratios expressed in constant prices. For example, the ratio of exports to GDP in current prices in 1996 was about 140 percent, while the ratio in 1990 prices was almost 200 percent. Trend developments in both ratios, however, have been broadly similar during the 1980s and 1990s.


The trend growth rate was estimated by applying the Hodrick-Prescott filter to actual real GDP growth rates over the past fifteen years. It may be noted that the estimated current growth rate is sensitive to the endpoints of the data series, and should be interpreted as a range rather than a point estimate.

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