AS PROTESTS grip Hong Kong and worries mount about how China might respond, one of the most unsettling questions for the city’s residents is whether its fate matters much to the rest of the country. Hong Kong has long served as the bridge between China and the world, conveying trade and investment flows both ways. That role has diminished in recent years as China has opened its borders and plugged itself directly into the global economy. Hong Kong's leaders warn that the current unrest will only result in Chinese businesses bypassing it even more. Judging by size, they have a point: Hong Kong is clearly less important than in the past. Its GDP has shrunk from 16% of China’s in 1997, the year it was returned to Chinese control, to 3% today. That has led many inside China and abroad to conclude that Hong Kong is fading towards economic irrelevance. Is it?
Not so fast. The focus on size alone is too simplistic. With China’s development over the past two decades, growth has spread around the country—no one city can dominate GDP when there are now nearly 200 cities with populations of more than 1m people and rapidly rising incomes. But in the financial sphere Hong Kong has remained indispensable to China. And in several dimensions its position has actually been consolidated, not eroded, in recent years. Hong Kong has proved to be more reliable than the mainland as a source of equity financing. Since 2012, Chinese companies have raised $43 billion in initial public offerings in the Hong Kong market, versus just $25 billion on mainland exchanges, according to Dealogic. More than anywhere else in the world, Hong Kong has also provided Chinese companies with access to global capital markets for bond and loan financing. What’s more, Hong Kong is the key hub for investment in and out of China. It accounted for two-thirds of foreign direct investment into China last year, up from 30% in 2005.
Although much of this money is simply passing through Hong Kong, foreign companies also use the city as their staging post for investing in China as it offers them something that no mainland city does: a stable investment environment, protected by fair, transparent courts that enforce long-established rule of law. And it is not just foreign companies and investors that turn to Hong Kong. Over the past five years, the Chinese government has made the city a testing ground for a range of financial reforms: the yuan’s path towards acceptance as a global currency began in Hong Kong in 2009 with an experiment in trade settlement; Hong Kong is also home to the biggest “dim sum” bond market—yuan-denominated debt that is issued overseas; and a soon-to-be-launched programme that will for the first time allow any foreign investor to buy China-listed shares will be conducted via the Hong Kong stock exchange. Hong Kong has been only too willing to host these experiments believing, rightly, that they are crucial to its survival as a thriving financial centre.
In short, China has benefited greatly from Hong Kong’s unique status. It is a city that is sealed off from the mainland but closely connected to it; a territory that is fully integrated into the global economy but ultimately controlled by the Communist Party in Beijing. Even with its unique status, however, there is no question where the balance of power lies in Hong Kong’s relationship with China: about half of Hong Kong’s exports end up in China; one-fifth of its bank assets are loans to Chinese customers; and tourism and retail spending, mostly from China, account for 10% of Hong Kong's GDP. In the opposite direction, the Chinese economy’s direct exposure to Hong Kong is vanishingly small. But it would be a grave mistake to conclude that Hong Kong therefore does not matter to China. If China were to do anything that jeopardised their special relationship, Hong Kong would suffer most; but China would also pay a heavy price.
