The Economic Relationship between the Mainland and Hong Kong

The Economic Relationship between the Mainland and Hong Kong Lawrence J. Lau, Ph. D. Ralph and Claire Landau Professor of Economics, The Chinese Univ. of Hong Kong and Kwoh-Ting Li Professor in Economic Development, Emeritus, Stanford University Friends of Hong Kong Association Limited Lecture Heep Yunn School Hong Kong, 16 May 2011 Tel: (852)3710-6888; Fax: (852)2104-6938 Email: lawrence@lawrencejlau.com; WebPages: www.igef.cuhk.edu.hk/ljl

Outline An Overview of the Mainland Chinese Economy Comparison of the Economies of Hong Kong and the Mainland Mainland-Hong Kong Economic Interactions Future Trends Concluding Remarks Lawrence J. Lau 2

An Overview of the Mainland Chinese Economy The Mainland has made tremendous progress in its economic development since it began its economic reform and opened to the World in 1978. The Mainland has made a smooth and successful transition from a centrally planned economic system to a market economic system. The Mainland of China is currently the fastest growing economy in the World averaging 9.8% per annum over the past 33 years. It is historically unprecedented for an economy to grow at such a high rate over such a long period of time. Lawrence J. Lau 3

An Overview of the Mainland Chinese Economy A commonly used measure of the size of an economy is GDP, or Gross Domestic Product. It is defined as the total value of all goods and services produced within the geographical boundaries of an economy in a given period of time, for example, a year or a quarter. The value of a good or a service is defined as its price less the costs of all the intermediate goods and services used in its production, but not the costs of direct capital and labour services. Lawrence J. Lau 4

An Overview of the Mainland Chinese Economy Real GDP is a concept used to compare the values of GDP at different points of time that are net of the effects of the changes in the prices of goods and services. A change in the nominal value of GDP due solely to changes in prices is not real because in real terms no more goods and services have been produced. Typically, real GDP is measured in terms of the fixed constant prices of a given period. We focus on real GDP because a change in the price of a good or a service, whether up or down, does not affect its utility to consumers. Lawrence J. Lau 5

An Overview of the Mainland Chinese Economy Between 1978 and 2010, Mainland Chinese annual real GDP grew more than 20 times, from US$304 billion to more than US$6.04 trillion (2010 prices) to become the second largest economy in the World, after the United States. By comparison, the U.S. GDP (approximately US$14.66 trillion in 2010 prices) was 2.4 times the Mainland Chinese GDP in 2010. Hong Kong GDP in 2010 was only US$225 billion, or 3.7% of the Mainland GDP. Lawrence J. Lau 6

Mainland Chinese Real GDP in US$ since 1952 (2010 Prices) 6,500 Chinese Real GDP, in 2010 prices 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Lawrence J. Lau 7 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Billions US$

An Overview of the Mainland Chinese Economy Despite the rapid growth of the Mainland, in terms of real GDP per capita (that is, per person), it is still a developing economy. Between 1978 and 2010, Mainland Chinese real GDP per capita grew almost 15 times, from US$316 to US$4,503 (in 2010 prices). By comparison, the U.S. GDP per capita (approximately US$47,274 in 2010 prices) was 10.5 times Mainland Chinese GDP per capita in 2010. Hong Kong GDP per capita in 2010 was US$31,813, or 7 times the Mainland GDP per capita. Mainland GDP per capita ranks below 90th among all countries in the World. Lawrence J. Lau 8

Real Mainland Chinese GDP per Capita in US$ since 1952 (2010 Prices) 5,000 Chinese Real GDP per Capita, in 2010 prices 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Lawrence J. Lau 9 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 US$

An Overview of the Mainland Chinese Economy While many problems have arisen in the Mainland Chinese economy within the past decade for example, increasing income disparity--both inter-regional and intra-regional-- uneven access to basic education and health care, environmental degradation, inadequate infrastructure and corruption it is fair to say that every Mainland Chinese citizen has benefitted from the economic reform and opening since 1978, albeit to varying degrees, and few want to return to the central planning days. Lawrence J. Lau 10

An Overview of the Mainland Chinese Economy The Central Government leaders have also demonstrated their ability to confront important challenges and solve difficult problems, as for example, in maintaining Mainland Chinese economic growth during the 1997-1998 East Asian currency crisis and the 2007-2009 global financial crisis. The Mainland of China is one of the very few socialist economies that have made a smooth transition from a centrally planned to a market system. It is a model for other transition economies such as Vietnam and potential transition economies such as Cuba, Laos, and North Korea. Lawrence J. Lau 11

Key Performance Indicators Before and After the Mainland Economic Reform Growth Rates percent per annum Period I Period II 1952-1978 1978-2010 Real GDP 6.15 9.79 Real GDP per Capita 4.06 8.66 Exports 9.99 17.23 Imports 9.14 16.37 Inflation Rates (GDP deflator) 0.50 5.47 1952-1978 1978-2009 Real Consumption Lawrence J. Lau 5.05 8.96 12 Real Consumption per Capita 2.99 7.79

An Overview of the Mainland Chinese Economy The Mainland has consistently had a high national savings rate in excess of 30%, which is more than adequate to finance all of its domestic investment needs. It does not need to depend on foreign direct investment, foreign portfolio investment, or foreign loans. The Mainland has an almost unlimited supply of surplus labour, ensuring that there will be little or no pressure on the real wage rate of unskilled, entry-level labour for decades to come. Lawrence J. Lau 13

An Overview of the Mainland Chinese Economy The huge potential domestic market of 1.34 billion consumers allows the economies of scale in production and in innovation to be easily realised on the Mainland. The Mainland also has a long tradition of emphasis on education and learning (human capital) and will be increasing its investment in human capital. The enrollment rate of tertiary education has been rising rapidly and stands at 24 percent today. It is expected to rise further over the next decades as private tertiary educational institutions become more numerous in response to demand and facilitated by government policy. Lawrence J. Lau 14

Savings Rates of Selected Asian Economies (1952-present) 60 50 China, Mainland Hong Kong India Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand Savings Rates of Selected East Asian Economies 40 30 20 10 0 Lawrence J. Lau, The Lawrence Chinese J. University Lau of Hong Kong 15 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Percent

An Overview of the Mainland Chinese Economy The huge domestic market of the Mainland greatly enhances the productivity of intangible capital (e.g., R&D capital, goodwill). The fixed research and development costs of a new product or process can be easily amortised over a large market. The benefits of investment in goodwill, e.g., brandbuilding, are also much greater in a large market. The huge domestic market also enables active Mainland Chinese participation in the setting of product and technology standards, for example, fourth-generation (4-G) standards for telecommunication, and sharing the benefits of such standard-setting. Lawrence J. Lau 16

An Overview of the Mainland Chinese Economy Brand-building is a pre-requisite for Mainland Chinese enterprises to re-orient themselves to take advantage of the huge domestic market. It is true that brand-building requires resources, but it also enables the owners of brand names to have much more pricing power and higher profit margins than enterprises that do only OEM (original equipment manufacturing) business. Examples of successful brand-building in the Mainland market include Haier, Kang Shifu and Wang Wang. Lawrence J. Lau 17

An Overview of the Mainland Chinese Economy In addition to a high national savings rate, a large pool of surplus labour, a huge domestic market, and rising investment in intangible capital (human capital and R&D capital), The Mainland also has the advantage of relative backwardness. It has: The ability to learn from the experiences of successes and failures of other economies; The ability to leap-frog and by-pass stages of development (e.g., the telex machine, the VHS video players, the fixed landline phones); and The possibility of creation without destruction (e.g., online virtual bookstores like Amazon.com do not have to destroy brick and mortar bookstores which do not exist in the first place). The Mainland also possesses an abundance of scientific and technical manpower the cost of which is a fraction of the cost in developed economies. Lawrence J. Lau 18

Comparison of the Economies of Hong Kong and the Mainland It is useful to compare the economies of Hong Kong and the Mainland over time. Huge changes have occurred over the past 30 odd years. In 1980, the GDP of the Mainland economy is only 5 times that of Hong Kong. Today, it is more than 25 times. However, in terms of GDP per capita, Hong Kong still leads the Mainland at 7 times in 2010, but the gap has shrunk significantly from 45 times in 1980. Lawrence J. Lau 19

Comparison of the Real GDPs of Mainland and Hong Kong (2010 US$) China 2010 2000 Hong Kong 1990 Lawrence J. Lau 1980 20

Comparison of the Real GDPs of Four Regions (2010 US$) 4,500 Comparison of the Real GDPs of the Four Regions in the Greater Chinese Economy US$ billion, 2010 prices 4,000 Mainland Hong Kong 3,500 Macau 3,000 Taiwan 2,500 2,000 1,500 1,000 500 0 Lawrence J. Lau 21 USD billions 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Comparison of the Real GDP-per-Capita s of Mainland and Hong Kong (2010 US$) Hong Kong 2010 2000 1990 China 1980 Lawrence J. Lau 22

Comparison of the Real GDP-per-Capita s of Four Regions (2010 US$) 60 Comparison of the Real GDP per Capita's of the Four Regions in the Greater Chinese Economy US$ thousand, 2010 prices Mainland 50 Hong Kong Macau 40 Taiwan 30 20 10 0 Lawrence J. Lau 23 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Thousand US$

Comparison of the Economies of Hong Kong and the Mainland In terms of international trade, the Mainland, which started out at a very low level in 1978, overtook Hong Kong in the early 1990s and is now approximately 4 times as large as Hong Kong. The Mainland is the most important trading partner of Hong Kong. In terms of foreign direct investment (FDI), the Mainland has consistently attracted more direct investment than Hong Kong since it adopted the economic reform and opening policies. Lawrence J. Lau 24

Comparison of the Total International Trade of the Mainland and Hong Kong 350 Total International Trade of the Mainland and Hong Kong 300 the Mainland Hong Kong 250 200 150 100 50 0 Lawrence J. Lau 25 USD billions Jan-1992 Apr-1992 Jul-1992 Oct-1992 Jan-1993 Apr-1993 Jul-1993 Oct-1993 Jan-1994 Apr-1994 Jul-1994 Oct-1994 Jan-1995 Apr-1995 Jul-1995 Oct-1995 Jan-1996 Apr-1996 Jul-1996 Oct-1996 Jan-1997 Apr-1997 Jul-1997 Oct-1997 Jan-1998 Apr-1998 Jul-1998 Oct-1998 Jan-1999 Apr-1999 Jul-1999 Oct-1999 Jan-2000 Apr-2000 Jul-2000 Oct-2000 Jan-2001 Apr-2001 Jul-2001 Oct-2001 Jan-2002 Apr-2002 Jul-2002 Oct-2002 Jan-2003 Apr-2003 Jul-2003 Oct-2003 Jan-2004 Apr-2004 Jul-2004 Oct-2004 Jan-2005 Apr-2005 Jul-2005 Oct-2005 Jan-2006 Apr-2006 Jul-2006 Oct-2006 Jan-2007 Apr-2007 Jul-2007 Oct-2007 Jan-2008 Apr-2008 Jul-2008 Oct-2008 Jan-2009 Apr-2009 Jul-2009 Oct-2009 Jan-2010 Apr-2010 Jul-2010 Oct-2010 Jan-2011

Comparison of the Inbound Foreign Direct Investment: Mainland and Hong Kong 120 Annual Inward Direct Investment of the Mainland and Hong Kong 100 Inward Direct Investment of Hong Kong Inward Direct Investment of the Mainland 80 US$ billions 60 40 20 0 Lawrence J. Lau 26 1998 1999 2000 2001 2002 2003Year2004 2005 2006 2007 2008 2009

Mainland-Hong Kong Economic Interactions: Direct Investment Hong Kong data on direct investment by country or region of origin are not completely reliable. On the one hand, Hong Kong direct investment can include not only investment from Hong Kong firms and residents, but also investment from Taiwan and elsewhere routed through Hong Kong subsidiaries as well as round-tripped investment, that is, investment from Mainland firms and residents camouflaged as Hong Kong firms in order to enjoy certain special tariff and tax privileges. On the other hand, there is also Hong Kong direct investment that is routed through tax havens such as the British Virgin Islands, Cayman Islands and Netherland Antilles. Hong Kong data and Mainland data on FDI do not agree. Taking into consideration all of these data problems, Hong Kong is still the most important source of foreign direct investment into the Mainland, accounting for between 20% and 40% of total FDI. Lawrence J. Lau 27

Annual Hong Kong Direct Investment to the Mainland (US$) 70 Hong Kong Direct Investment into the Mainland 60 Hong Kong Direct Investment (Hong Kong Data) Hong Kong Direct Investment (Chinese Data) 50 40 US$ Billion 30 20 10 0 Lawrence J. Lau 28 1995 1996 1997 1998 1999 2000 2001 2002Year2003 2004 2005 2006 2007 2008 2009 2010

Hong Kong Direct Investment as a Percent of Total Inbound Direct Investment 120 Hong Kong Direct Investment as a Percent of Total Inbound Foreign Direct Investment inito China 100 Percent (Chinese Data) 80 Percent (Hong Kong Data) Percent 60 40 20 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Lawrence J. Lau 29 Year 2006 2007 2008 2009 2010

Mainland-Hong Kong Economic Interactions: Direct Investment Hong Kong investors were the first to invest in the Mainland when it first opened to the World and were instrumental for the successful development of the Special Economic Zones such as Shenzhen. It is fair to say that without Hong Kong, Shenzhen would probably not have been a success. The other Special Economic Zones have not been notably successful. But today, even total foreign direct investment, from all sources, constitutes only a very small and quantitatively unimportant percentage of total gross domestic investment on the Mainland (less than 5% in 2010). Mainland investment now constitutes almost 50% of all FDI into Hong Kong. Lawrence J. Lau 30

15 10 5 0 Foreign Direct Investment as a Percent of Total Mainland Domestic Investment Foreign Direct Investment as a Percent of Total Mainland Gross Domestic Investment Lawrence J. Lau 31 Percent 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Mainland Investment as a Percent of Total Inbound Direct Investment of Hong Kong 50 Mainland Investment as a Percent of Inbound Direct Investment of Hong Kong 45 40 35 Percent 30 25 20 15 10 Lawrence J. Lau 32 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Mainland-Hong Kong Economic Interactions: International Trade Trade between Hong Kong and the Mainland has grown rapidly since 1978. The Mainland has become the most important trading partner of Hong Kong. It is the most important destination for Hong Kong exports as well as the most important source of Hong Kong imports. The Mainland has also become the most important source of visitors to Hong Kong, especially since the introduction of the Individual Visit Scheme in 2003. Mainland visitors constituted more than 60% of all visitors to Hong Kong in 2010. Mainland visitors spend on average 3 days in Hong Kong and US$750 Lawrence per J. Lau day. 33

25 20 15 10 5 0 Total Hong Kong Exports to and Imports from the Mainland since 1972 Hong Kong Total Exports to and Imports from the Mainland Hong Kong Total Exports to the Mainland Hong Kong Imports from the Mainland Lawrence J. Lau 34 USD billions Jan-1972 Jul-1972 Jan-1973 Jul-1973 Jan-1974 Jul-1974 Jan-1975 Jul-1975 Jan-1976 Jul-1976 Jan-1977 Jul-1977 Jan-1978 Jul-1978 Jan-1979 Jul-1979 Jan-1980 Jul-1980 Jan-1981 Jul-1981 Jan-1982 Jul-1982 Jan-1983 Jul-1983 Jan-1984 Jul-1984 Jan-1985 Jul-1985 Jan-1986 Jul-1986 Jan-1987 Jul-1987 Jan-1988 Jul-1988 Jan-1989 Jul-1989 Jan-1990 Jul-1990 Jan-1991 Jul-1991 Jan-1992 Jul-1992 Jan-1993 Jul-1993 Jan-1994 Jul-1994 Jan-1995 Jul-1995 Jan-1996 Jul-1996 Jan-1997 Jul-1997 Jan-1998 Jul-1998 Jan-1999 Jul-1999 Jan-2000 Jul-2000 Jan-2001 Jul-2001 Jan-2002 Jul-2002 Jan-2003 Jul-2003 Jan-2004 Jul-2004 Jan-2005 Jul-2005 Jan-2006 Jul-2006 Jan-2007 Jul-2007 Jan-2008 Jul-2008 Jan-2009 Jul-2009 Jan-2010 Jul-2010 Jan-2011

60 50 40 30 20 10 0 Hong Kong Exports to the Mainland as a Percent of Total Hong Kong Exports Hong Kong Exports to the Mainland as a Percent of Total Hong Kong Exports Lawrence J. Lau 35 Percent Jan-1972 Jul-1972 Jan-1973 Jul-1973 Jan-1974 Jul-1974 Jan-1975 Jul-1975 Jan-1976 Jul-1976 Jan-1977 Jul-1977 Jan-1978 Jul-1978 Jan-1979 Jul-1979 Jan-1980 Jul-1980 Jan-1981 Jul-1981 Jan-1982 Jul-1982 Jan-1983 Jul-1983 Jan-1984 Jul-1984 Jan-1985 Jul-1985 Jan-1986 Jul-1986 Jan-1987 Jul-1987 Jan-1988 Jul-1988 Jan-1989 Jul-1989 Jan-1990 Jul-1990 Jan-1991 Jul-1991 Jan-1992 Jul-1992 Jan-1993 Jul-1993 Jan-1994 Jul-1994 Jan-1995 Jul-1995 Jan-1996 Jul-1996 Jan-1997 Jul-1997 Jan-1998 Jul-1998 Jan-1999 Jul-1999 Jan-2000 Jul-2000 Jan-2001 Jul-2001 Jan-2002 Jul-2002 Jan-2003 Jul-2003 Jan-2004 Jul-2004 Jan-2005 Jul-2005 Jan-2006 Jul-2006 Jan-2007 Jul-2007 Jan-2008 Jul-2008 Jan-2009 Jul-2009 Jan-2010 Jul-2010 Jan-2011

60 50 40 30 20 10 0 Hong Kong Imports from the Mainland as a Percent of Total Hong Kong Imports Hong Kong Imports from the Mainland as a Percent of Total Hong Kong Imports Lawrence J. Lau 36 Percent Jan-1972 Jul-1972 Jan-1973 Jul-1973 Jan-1974 Jul-1974 Jan-1975 Jul-1975 Jan-1976 Jul-1976 Jan-1977 Jul-1977 Jan-1978 Jul-1978 Jan-1979 Jul-1979 Jan-1980 Jul-1980 Jan-1981 Jul-1981 Jan-1982 Jul-1982 Jan-1983 Jul-1983 Jan-1984 Jul-1984 Jan-1985 Jul-1985 Jan-1986 Jul-1986 Jan-1987 Jul-1987 Jan-1988 Jul-1988 Jan-1989 Jul-1989 Jan-1990 Jul-1990 Jan-1991 Jul-1991 Jan-1992 Jul-1992 Jan-1993 Jul-1993 Jan-1994 Jul-1994 Jan-1995 Jul-1995 Jan-1996 Jul-1996 Jan-1997 Jul-1997 Jan-1998 Jul-1998 Jan-1999 Jul-1999 Jan-2000 Jul-2000 Jan-2001 Jul-2001 Jan-2002 Jul-2002 Jan-2003 Jul-2003 Jan-2004 Jul-2004 Jan-2005 Jul-2005 Jan-2006 Jul-2006 Jan-2007 Jul-2007 Jan-2008 Jul-2008 Jan-2009 Jul-2009 Jan-2010 Jul-2010 Jan-2011

Annual Mainland and Total Visitors to Hong Kong since 1990 40 Annual Mainland and Total Visitors to Hong Kong 35 30 Total Visitors Visitors from the Mainland 25 Billion Persons 20 15 10 5 0 Lawrence J. Lau 37 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Visitors from the Mainland as a Percent of Total Visitors to Hong Kong 70 Visitors from the Mainland as a percent of Total Visitors 60 50 40 Percent 30 20 10 0 Lawrence J. Lau 38 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

The Yuan-Hong Kong Dollar Exchange Rate The Yuan-Hong Kong Dollar exchange rate also reflected the relative fortunes of the Mainland and Hong Kong economies. The Hong Kong Dollar was worth less than the Yuan until 1994, when the Yuan became current accounts convertible. The Hong Kong Dollar then became worth more than the Yuan, until the Yuan began to appreciate in mid-2005. The Hong Kong Dollar is now worth approximately 0.83 Yuan. Lawrence J. Lau 39

The Yuan-HK$ Exchange Rate End of Month, Yuan/HK$ 1.2 Yuan per Hong Kong Dollar at the End of the Month 1.0 0.8 0.6 0.4 0.2 0.0 Lawrence J. Lau 40 M1 1957 M1 1958 M1 1959 M1 1960 M1 1961 M1 1962 M1 1963 M1 1964 M1 1965 M1 1966 M1 1967 M1 1968 M1 1969 M1 1970 M1 1971 M1 1972 M1 1973 M1 1974 M1 1975 M1 1976 M1 1977 M1 1978 M1 1979 M1 1980 M1 1981 M1 1982 M1 1983 M1 1984 M1 1985 M1 1986 M1 1987 M1 1988 M1 1989 M1 1990 M1 1991 M1 1992 M1 1993 M1 1994 M1 1995 M1 1996 M1 1997 M1 1998 M1 1999 M1 2000 M1 2001 M1 2002 M1 2003 M1 2004 M1 2005 M1 2006 M1 2007 M1 2008 M1 2009 M1 2010 M1 2011

The Yuan-HK$ Exchange Rate Monthly Average, Yuan/HK$ Monthly Average Exchange Rate of Yuan per Hong Kong Dollar 1.2 1.1 1 0.9 0.8 0.7 0.6 Lawrence J. Lau 41 Jan-93 Apr-93 Jul-93 Oct-93 Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

Mainland-Hong Kong Economic Interactions: The Stock Market Stock exchanges on the Mainland were first established in the early 1990s. In terms of market capitalisation the total value of all the companies listed on the stock exchange at the prevailing share prices of the market the Shanghai Stock Exchange alone now exceeds the Hong Kong Stock Exchange. Mainland firms now constitute more than 50% of the Hong Kong Stock Exchange by market capitalisation but less than 20% by the number of listed firms indicating that the Mainland firms listed on the Hong Kong Stock Exchange are on average much bigger than the other firms listed there. Lawrence J. Lau 42

Comparison of Market Capitalisations of Mainland and Hong Kong Stock Exchanges 4,000 End-of-Year Market Capitalisation of Selected Stock Exchanges, in US$ billions 3,500 Hong Kong Exchanges 3,000 Shanghai SE USD billions 2,500 2,000 1,500 Shenzhen SE 1,000 500 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Lawrence J. Lau 43 Year 2001 2002 2003 2004 2005 2006 2007 2008 2009

Year-End Market Capitalisation of Mainland and All Firms Listed on HKSE 25,000,000 Market Capitalisation of Mainland and All Companies on the Hong Kong Stock Exchange, million HK$ Total 20,000,000 Mainland Companies 15,000,000 Million HK$ 10,000,000 5,000,000 0 Lawrence J. Lau 44 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09

Year-End Market Capitalisation of Mainland and All Firms Listed on HKSE 60 The Proportions of Mainland Companies on the Hong Kong Stock Exchange By Market Capitalisation 50 By the Number of Listed Companies 40 30 20 10 0 Lawrence J. Lau 45 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Percent

Mainland-Hong Kong Economic Interactions: The Stock Market In terms of initial public offerings (IPOs), that is, the first-time sales of shares by firms to public investors on the stock exchange, Mainland firms have been the mainstay of the Hong Kong Stock Exchange, accounting for most of the value of its IPOs, except in the global financial crisis years of 2009 and 2010 when firms from other countries came to Hong Kong to raise money because of the lack of activities in New York and London. Increasingly, however, Mainland firms find listing on the Shanghai Stock Exchange much more attractive because there is substantial domestic investor demand and the firms need to raise Renminbi rather than foreign exchange. The Mainland, with foreign exchange reserves exceeding US$3 trillion, does not need any more inflow of foreign exchange. That is why Hong Kong has to seek firms from other countries and regions to list their shares on the Hong Kong Stock Exchange. Lawrence J. Lau 46

Annual IPO Value of Mainland and All Firms on Hong Kong Stock Exchange 500 Annual IPO Value of Mainland and All Firms on Hong Kong Stock Exchange 450 400 All Firms The Mainland Firms 350 HKD billions 300 250 200 150 100 50 0 Lawrence J. Lau 47 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Mainland-Hong Kong Economic Interactions Hong Kong and its entrepreneurs were indispensable for the success of the economic reform and open-door policy on the Mainland, and in Guangdong and Shenzhen in particular. Hong Kong may not be the only gateway to the Mainland any more, but it can be the best gateway, or at least the best gateway to southern China. Hong Kong should capitalise on its geographical position to co-operate closely with Shenzhen, Pearl River Delta, Guangdong and southern China. Hong Kong can compete effectively with Shanghai as an international financial centre only if Hong Kong becomes more closely integrated economically with Guangdong (including Shenzhen). Guangdong, Hong Kong and Macau together can potentially Lawrence J. Lau 48 become an economy as large as that of Japan today.

Real GDPs of Hong Kong and Its Neighbouring Economies, billion 2010US$ 600 Real GDPs of Hong Kong and Its Neighbouring Economies, billion 2010 US$ Hong Kong 500 Macao Guangdong Excluding Shenzhen 400 Shenzhen 300 200 100 0 Lawrence J. Lau 49 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 USD billions

Real GDP-per-Capita s of Hong Kong and Its Neighbouring Economies, 2010 US$ 60,000 Real GDP per Capita's of Hong Kong and Its Neighbouring Economies, 2010 US$ Hong Kong 50,000 Macao Guangdong Excluding Shenzhen Shenzhen 40,000 30,000 20,000 10,000 0 Lawrence J. Lau 50 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 USD

Populations of Hong Kong and Its Neighbouring Economies, millions 120 Popoulations of Hong Kong and Its Neighbouring Economies, millions 100 60 40 20 0 Lawrence J. Lau 51 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Millions 2010 Guangdong ex Shenzhen Shenzhen Macao 80 Hong Kong Year

Mainland-Hong Kong Economic Interactions Guangdong has a permanent population of approximately 95 million, which together with Hong Kong and Macao is as large as Japan and more than a third as large as the United States. Guangdong has a GDP in excess of US$600 billion, approximately the same size as Taiwan, and a per capita GDP in excess of US$6,500. Lawrence J. Lau 52

Mainland-Hong Kong Economic Interactions Guangdong has a diversified industrial base with light industry, heavy industry and high-technology industries. but is relatively weak in the higher education and research and development sectors. Hong Kong has little or no industry, especially high-technology industry, but has world-class research universities to provide scientific and technological manpower and R&D. There is therefore room for specialization and division of labour among Hong Kong, Guangdong and Shenzhen, which can be win-win for all. Lawrence J. Lau 53

Future Trends If current trends continue, Mainland Chinese real GDP will approach the level of U.S. real GDP in approximately 15 years time--around 2025, at which time Mainland Chinese real GDP will exceed US$20 trillion (in 2010 prices) and Mainland Chinese real GDP per capita will exceed US$ 14,000. By that time, 2025, the Mainland and the U.S. will each account for approximately 15% of World GDP. Lawrence J. Lau 54

Actual and Projected Mainland Chinese and U.S. Real GDP (trillion 2010 US$) 260 Actual and Projected Real GDP of China and the U.S., in 2010 prices 240 220 Real GDP of the U.S. 200 Real GDP of China 180 160 140 120 100 80 60 40 20 0 Lawrence J. Lau 55 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050 USD trillions

Future Trends It will take another 20-25 years, between 2045 and 2050, before the Mainland reaches the same level of real GDP per capita as the United States, at US$90,000 in 2010 prices (bear in mind that in the meantime, the U.S. economy will also continue to grow, albeit at rates significantly lower than those of the Mainland Chinese economy and that the Mainland Chinese population will reach a peak around 2035 and then begin to decline slowly). By that time, Mainland Chinese GDP will be approximately 6 times the U.S. GDP, and will account for between a third and a half of World GDP (depending on the growth rates of other economies, especially the developing economies of today). Lawrence J. Lau 56

Actual and Projected Mainland Chinese and U.S. Real GDP per Capita (2010 US$) Actual and Projected Real GDP per capita of China and the U.S., in 2010 prices 130 120 Real GDP per capita of the U.S. 110 Real GDP per capita of China 100 90 80 70 60 50 40 30 20 10 0 Lawrence J. Lau 57 USD thousand 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 2050

Concluding Remarks Hong Kong was indispensable to the initial success of the Mainland s economic reform and opening to the World. However, with the success of the Mainland economy, the fate of the Hong Kong economy is now inextricably intertwined with that of the Mainland. The Mainland is now critically important to the Hong Kong economy. If the Mainland economy prospers, the Hong Kong economy will prosper. If the Mainland economy slows, the Hong Kong economy will slow. Lawrence J. Lau 58

Concluding Remarks It is because of the strength of the Mainland economy that Hong Kong has been able to survive the 2007-2009 global financial crisis relatively unscathed as well as the earlier East Asian currency crisis in 1997-1998. The Individual Visit Scheme has been instrumental in lowering the unemployment rate of Hong Kong down to its current 3.2%. Hong Kong must try to take full advantage of its Mainland opportunities so that its economy can continue to grow, especially given that the United States and European economies remain mired in recession and unlikely to resume normal growth any Lawrence time J. Lau soon. 59