In terms of the direction of China’s economic future, think of Hong Kong as the “canary in the coal mine.” As the protest movement in Hong Kong grows over concerns about the island’s democratic future, the question is whether Beijing will intervene.
A crackdown, Tiananmen-style or otherwise, would not be wise because Hong Kong remains critical to China’s economy. While Hong Kong’s economy is now only 3 percent the size of the mainland, Hong Kong is China’s most important economic conduit. It handles about one-fifth of the mainland’s foreign trade and is the largest source of foreign capital for mainland companies.
For China to become a high-income country, it must continue liberalizing its financial sector, which remains undeveloped and dominated by the banking system. Hong Kong is the key channel for this liberalization. For example, most of China’s investment comes in and out through Hong Kong. Chinese companies primarily raise yuan-denominated capital through the “dim sum” bond market in Hong Kong. According to The Economist and Dealogic, in the past two years alone, Chinese companies have raised $43 billion in initial public offerings in Hong Kong versus just $25 billion on the mainland exchanges. There are approximately 750 mainland companies listed in Hong Kong with a market capitalization of approximately $1.5 trillion. Later this year, a Shanghai–Hong Kong stock linkage will allow foreigners to buy Chinese listed shares in Hong Kong. (Foreign ownership of Chinese shares is largely restricted from foreigners.)
Hong Kong companies are subject to rigorous international standards of accounting and transparency. Mainland companies sell at some of the lowest valuations in the world given their abysmal investor transparency. Mainland companies will never become global brands without the emulation of Hong Kong’s investor protection.
The loss of Hong Kong would cost China the economic model international investors hope it will emulate. In The Heritage Foundation/Wall Street Journal 2014 Index of Economic Freedom, Hong Kong ranked first out of 186 countries. Within the 10 sub-categories, it ranked first in business, trade, and financial freedoms and second in protection of property rights and investment freedom. China, on the other hand, ranked 137, scoring miserably in investment and business freedoms (152nd and 153rd, respectively) and protection of property rights (139th).
China could easily suppress Hong Kong’s economic vitality through a mishandling of the current political impasse. That would be a clear signal to the world that China’s economic miracle days are numbered.
