New MERICS study on Hong Kong’s economic future

The political crisis that has gripped Hong Kong since March 2019 is far from resolved. The Chinese government’s responses to the protests are undermining the city’s institutional pillars. Hong Kong’s status as a financial gateway is at risk as the city is caught between the differing needs of China’s government and international business, according to MERICS researchers Max J. Zenglein and Maximilian Kärnfelt. The authors of the new MERICS study „Financial hub at risk. How China’s reaction to protests jeopardizes Hong Kong’s status” argue the protest movement and government responses also pose a dilemma for Beijing: China cannot enjoy the benefits of both political control and a liberal economic environment.

Hong Kong's position as a financial hub rests on its high degree of autonomy. The city’s status as a Special Administrative Region has given it the freedom to meet the institutional requirements to remain an international hub for finance and trade. Hong Kong’s freedoms – in particular the rule of law and a lack of capital controls – are thus essential for China as it tries to satisfy its growing appetite for foreign capital.

The protests have affected Hong Kong’s economy, causing the city’s first recession since 2009. Hard-hit sectors include retail, restaurants, hospitality, transportation and events – even if the real estate market remains fairly stable for now. The city’s function as an offshore financial center has so far not been affected. There have been no major capital outflows, and the Hong Kong Stock Exchange (HKEX) continues to attract major IPOs. With the listing of Anheuser-Busch’s Asian unit and the secondary listing of Alibaba, it even topped the global ranking of IPO locations last year. But the city's ability to attract new companies and talent has suffered – ever more expatriate executives, for example, are relocating their families elsewhere.

The authors argue that China has no credible alternative to Hong Kong in the short to medium term.  Hong Kong’s role as China’s gateway to global financial markets is currently unique. The city provides China access to foreign exchange and is helping to integrate the country’s financial system into global markets. Shanghai and Shenzhen are in no position to take over because of their strict capital controls, and the absence of both a freely convertible currency and the rule of law. Alternative offshore centers like Macau, Singapore or London are at best complementary hubs – cities beyond mainland China have considerable political and economic constraints.

However, the crisis has the potential to undermine the institutions upon which Hong Kong’s liberal economy relies. The authors look at different reasons why Hong Kong’s status as a popular offshore financial center (OFC) is at risk: escalating economic and financial crisis, Hong Kong’s need for international recognition of its special trading status, political pressure on companies that could erode economic freedom, and Beijing’s hardline measures that could undermine the city’s independent judiciary. 

According to a MERICS survey of experts and professionals in Hong Kong, a majority of 71.2 per cent expect the city to remain functional even as protests continue, 22.9 per cent foresee business as usual as protests fade and stability returns, and only six per cent worry that a deterioration in stability could cause significant, lasting damage.

Zenglein and Kärnfelt conclude with a warning: Growing distrust in Hong Kong’s institutions jeopardizes its position as an offshore financial center. Beijing’s hardline course threatens to inflict substantial and irreparable damage on the city’s institutions. As a result, Chinese pressure for accelerated convergence with the mainland’s political and legal system has reached a critical point. Given that Beijing has no credible alternative financial gateway, the premature demise of Hong Kong’s global function would be costly for China. In that event, European businesses would face the challenge of losing the institutional convenience Hong Kong provides.

You can read the full report „Financial hub at risk. How China’s reaction to protests jeopardizes Hong Kong’s status” here.