30 November 2017

A 21st century hub: Can Hong Kong adapt?

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A few of the major trends in global trade and finance that have benefited Hong Kong over the past three decades are changing in ways that could prove detrimental to its economy if it can't adapt. The most influential is the evolution of regional supply chains, most of which came to run through Hong Kong in one way or another during this period. Another is the increased competition from other cities in Asia, such as Singapore and Shanghai. Then there is the matter of the financial services industry, a sector vital to the HKSAR's growth and undergoing a technology-induced revolution. How Hong Kong adjusts to each of these will determine whether it will remain a key trading hub in the 21st century.

Delinking the chains

At its peak in 2013, trade between Hong Kong and mainland China, Hong Kong's largest trading partner, totalled nearly US $ 590bn. The value of trade between the two has shrunk every year since and in 2016 was down to $530bn.

In part, this was a product of weak global demand, but it was likely also a result of the ongoing transformation in the structure of regional supply chains. In its role as an entrepot, Hong Kong benefited greatly from China's integration into the global economy. Many of the intermediate goods that went into--and still continue to go into--China for assembly pass through Hong Kong, as do many of the finished products that come back out. In recent years, however, with labour costs rising on the mainland, firms are now beginning to route their supply chains through other countries, particularly in Southeast Asia. While it's still early days, labour costs in China figure to rise even higher, providing further impetus for companies to move production elsewhere It's an unwelcome trend for Hong Kong.

The challenges ahead

Hong Kong performs well on almost all measures of overall economic and commercial competitiveness. In the World Economic Forum's most recent Global Competitiveness Index, a rundown of the world's most agile economies, Hong Kong ranks 6th overall, an improvement of three places from the last iteration of the index, and the World Bank's Ease of Doing Business rankings it comes in 5th, ahead of the United States.

There are causes for concern, however. In the latest Global Financial Centres Index, for example, Hong Kong finds itself squeezed between a dominant Singapore and an ascendant Shanghai1. Meanwhile, neighbouring Shenzhen regularly grabs headlines about the dynamism of its technology sector. Pundits from various corners have been scratching their heads about how to turbo-charge the economy.

Innovation in finance

One answer, according to Henri Arslanian, FinTech and RegTech Leader, China & Hong Kong of global consultancy PwC, is to marry the forward-thinking spirit of a fast-moving start-up scene with the chief industry Hong Kong dominates: finance. So-called fintech has the potential to turn Hong Kong into a springboard for innovation in a region which is hungry for it, says Mr Arslanian, as long as the city can figure out how to showcase its natural advantages to the global start-up community.

"If you want to sell your fintech solution to financial institutions who are receptive to these new innovations, you have to come to Asia, and Hong Kong is a great spot," he says, citing Hong Kong’s high concentration of investment banks, the transparency and consistency of its regulatory structure, and the depth of its capital markets (which dwarfs Singapore’s2 ).

Mr Arslanian agrees that Singapore has excelled at attracting small players and giving fintech businesses an environment in which to thrive, while Hong Kong is catching up by establishing liaison offices in numerous overseas locales and aggressively marketing itself as Asia’s fintech capital in places like London and San Francisco.

Legal maneuvering

Another potential road to riches lies in the so-called regulatory technology, or "regtech" space, according to Mr Arslanian. This concept centres on next-generation ways to help financial services firms comply with local and cross-border laws, such as via automated monitoring of compliance channels for updates from officials3 , or of online transactions for potential illegal activity by customers4. "Banks are spending crazy amounts of money just to comply with the various regulatory requirements," says Mr Arslanian. "The average financial organization in Asia is dealing with a dozen different countries at least, and that’s a lot of headache."

Hong Kong’s stable, clear and well-enforced regulations make it an ideal place for banks to adopt and refine such regtech solutions before deploying them in less transparent economies around Asia, according to Mr Arslanian. Hong Kong officials have also been pushing tools like regulatory sandboxes, which allow organisations to test out fintech applications in a controlled environment, before rolling them out to the broader market. In this regard, Singapore has the edge with only one regulatory body to Hong Kong’s three.

More tech, less fin

In a broader sense, some of the jitters surrounding Hong Kong’s future prospects reflect deeper worries about its ability to cultivate a pool of talent. The region ranks only 14th in the higher education and training section of the WEF report, and 26th in innovation; indicators like "availability of scientists and engineers" are particular weak spots5. "I think one area Hong Kong needs to improve is talent, not on the ‘fin’ side but on the ‘tech’ side." says Mr Arslanian.

Hong Kong’s government has issued extensive guidelines promoting science and technology in the education system6. Whether these will be enough to give Hong Kong the boost it needs remains to be seen. "In China, they have no lack of skills," says Mr Arslanian. "Training the right generation of talent to be able to flourish in the community—it's a big issue." says Mr Arslanian

Developing and employing technology will not only be important to trade in physical goods, but will be a source of trade flows itself in the form of services. If Hong Kong is to be a 21st century hub, it has to become as skilled in facilitating the flows of data and ideas as it in facilitating flows of electronics and apparel.

© 2017 The Economist Intelligence Unit Ltd. All rights reserved.

Whilst efforts have been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor its affiliates can accept any responsibility or liability for reliance by any person on this information.

  1. The Global Financial Centres Index 21, China Development Institute and Z/Yen Partners (2017)
  2. "The subdued mood in Singapore's financial industry", The Economist (9 March 2017)
  3. RegTech is the new FinTech: How agile regulatory technology is helping firms better understand and manage their risks, Deloitte (2016)
  4. "Regtech Definition", Investopedia (no date)
  5. Global Competitiveness Report
  6. Report on Promotion of STEM Education: Unleashing Potential in Innovation, Hong Kong Education Bureau (2016)

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