U.S. and Hong Kong (1985-1997)

03/05/97

SUMMERS ON HONG KONG'S ECONOMIC FUTURE

Following is the text of Summers' speech:

(begin text)

INTRODUCTION

It's great to be here in Hong Kong. This city impresses me not only for its spectacular architecture, but for what those buildings house -- one of world's most active currency markets, Asia's second largest stock market, key operations of the world's great banks, and some of the world's shrewdest financial professionals in both the public and private sector.

The importance of the future of Hong Kong to the United States is measured not just by the huge value of trade between our two economies, the scale of our investment here, or by the volume of financial flows, but also by number of our citizens whose livelihoods depend on Hong Kong's prosperity.

-- Some 35,000 American citizens live here. And the 1100 U.S. firms that have invested $14,000 million in Hong Kong employ some 250,000 people, 10% of the total work force.

What's more, our governments are engaged in close collaboration on a wide array of efforts to fight organized crime -- narcotics trafficking, money laundering, and smuggling.

The reversion process has focused a great deal of attention on Hong Kong, and rightly so, given its importance to the global economy.

But it occurs to me, as I look forward, that many people are missing a very important facet of Hong Kong reversion. The majority appear to view transition as something that China is "doing to" Hong Kong.

-- But the reversion process is hardly a one-way street. The transition will potentially have just as big an impact on China.

Today, I'd like to say a few words about what the interplay between the two great economies within the "one country two systems" framework means for Hong Kong, for China and for the world.

FRAMEWORK FOR TRANSITION

Hong Kong's reversion to China is in many ways a political event unparalleled in history. It marks the takeover of a capitalist, democratic society by a socialist one, but with strong guarantees of the combined system and life- style of the former.

A great deal of attention has been paid to the process surrounding this shift. On the economic and financial aspects, of which I feel more competent to speak, the authorities involved have taken many of the steps necessary to make for a smooth transition.

-- In terms of a legal framework, the Joint Declaration and Basic Law lay the basis for a transition that can preserve what has made Hong Kong so special and so successful as an economy.

(a) Hong Kong is to retain its autonomy in economic affairs, including its independent fiscal and monetary policy under the guidance of an extremely competent civil service.

(b) Hong Kong is also to retain its status as an international financial center, and its own currency -- separate from the renminbi.

-- Hong Kong has ensconced itself well in the international financial system -- reinforcing its separate role as a financial player. These are moves that China has supported.

(a) Hong Kong is a participant in the New Arrangement to Borrow (NAB) recently agreed by the international financial community. It recently joined the Bank for International Settlements. Hong Kong will continue to be a key member of APEC, and will retain its separate membership in the major international financial institutions.

-- Hong Kong's financial and economic civil servants are recognized as world class by their global counterparts. I am looking forward to seeing my Hong Kong counterpart at the upcoming gathering of finance and monetary officials in Tokyo.

(a) Reflecting their high professionalism, Mr. Tung's recent decision to leave current cabinet members in their posts -- including Hong Kong's extremely competent economic team -- is very welcome. It adds weight to the reassurances that have been given at the highest political levels that Hong Kong's sound financial and economic system will remain intact.

-- Hong Kong has also taken measures to ensure that it has the resources to preserve economic and monetary stability should market confidence be rocked by some unanticipated development.

(a) Hong Kong's foreign exchange reserves are now about $64,000 million -- a sizable cushion against exchange rate instability or shock to the balance of payments.

(b) Access to liquidity has been reinforced by a network of nine repurchase agreements that the Hong Kong Monetary Authority has set up with other central banks in the region.

(c) The Hong Kong dollar is further backed up by China's pledge to protect it with its own massive reserves of over $100,000 million should it come to that.

-- Hong Kong officials at the highest levels have been active in explaining such arrangements in international financial circles and national capitals, including ours.

At least so far, the markets have evaluated these aspects of the transition favorably.

-- Property markets have shown remarkable growth in the last six months, and the Hang Seng Index is at its highest levels since 1994.

-- It is also noteworthy that Hong Kong's government borrows in Hong Kong dollars at rates lower than those of the United States for periods of as much as two years.

But as one central banker's favorite cliches has it: Credibility is not owned; it is rented.

-- After the all the excitement, when legalities of reversion are concluded and after Hong Kong hosts this year's annual meetings of the IMF and World Bank in the autumn, it will be essential for all political authorities to continue to behave in a way conducive to the maintenance of market confidence.

It is crucial that this transition go well, not just for Hong Kong but for China as well. Apart from questions of international politics and prestige, the transition is a matter of economics for both.

BENEFITS FOR CHINA

China is -- and has been for the past 19 years -- in the midst of an economic transformation of immense proportions. This transformation has progressed from experimentation with market pricing of goods to the development of highly active capital markets in Shanghai and Shenzhen.

Each phase of China's reform process has introduced a greater reliance on market forces.

-- Early on, China experimented with material incentives to boost production and set up special economic zones to attract foreign direct investment and develop exports. China then undertook broader reforms to re-shape its economy -- including enterprise taxation, wage reform, and the breakup of the monobank system.

-- Most recently, China has managed its first soft macroeconomic landing and is now turning in earnest to the structural deficiencies -- such as the state enterprise system and the financial sector -- that badly need reform.

At this juncture in China's transformation, more than ever, Hong Kong has a great deal to offer China.

-- Clearly, in the area of investment, Hong Kong's entrepreneurs, their capital and technological resources, have been an essential ingredient in China's economic growth.

(a) Between 1991 and 1995, Hong Kong invested more than $68,000 million in China.

(b) Conversely, China has taken advantage of opportunities in Hong Kong. China's estimated stock of direct investment in Hong Kong at end 1995 was $25,000 million -- second only to the United Kingdom.

-- Hong Kong has also provided China with the opportunity to import financial products from one of the most innovative financial centers in the would.

-- But perhaps Hong Kong's greatest potential value to China is as a source of good ideas, technical expertise, and as an exemplar or model for the kind of system that can bring China the most economic success.

(a) First, Hong Kong has a very impressive record on macroeconomic management: High economic growth, prudent fiscal management and government surpluses, and experience in dealing with capital flows and an open foreign exchange system. Hong Kong has the people to convey this kind of knowledge.

(b) Second, Hong Kong's regulators have invaluable experience in financial systems and regulation. The bumps that have occurred on this road, and the improved market oversight and regulation that have emerged as a result, have only increased Hong Kong's credentials as a source of wisdom for China.

(c) Third, China could draw on Hong Kong's example of clearly delineating the role of government in the economy.

(d) Fourth, Hong Kong is a sterling example of the benefits of integration with the world economy. Hong Kong's economic success has depended on its ability to take advantage of the opportunities in global markets -- making it a trade leader in Asia and a living example of the benefits of open markets.

(i) This is especially true for financial services, where Hong Kong has generally maintained a high standard for market access. Hong Kong's example of the value of financial liberalization, accompanied by strong prudential supervision, should be studied by other emerging Asian economies as they consider their offers in the current round of financial services negotiation.

(e) Finally, Hong Kong, and the Hong Kong people, have a deep understanding of how markets are supposed to work. This is exactly the kind of knowledge that China will have to draw on again and again if it wants to build the kind of economy that will work in the 21st century.

FREEDOM AND ECONOMIC PROSPERITY

Any accurate economic history of the latter part of the 20th century will have to give due attention to two striking developments: the transformation of industrial economies into information-intensive economies based on services; and the inclusion of millions of Asians in an paralleled rise in global prosperity. Hong Kong, with its world-class financial sector, has been at the vanguard of both of these developments. In the 21st century, China, with its vast resources and Hong Kong as an exemplar, has the potential to follow suit.

I noted earlier that authorities on both sides have made good preparations to permit a smooth economic transition. I sense, however some many believe that politics and economics are somehow mutually exclusive. This is too simple a view.

There is no firewall between economic freedom and freedom in its many other dimensions. The free flow of information is essential to free society, to free markets, and to a strong financial system. It is essential to Hong Kong's prosperity -- and to China's -- that information flow freely.

Integrity also is central to both economics and politics. Hong Kong's success as a financial center has been based to no small extent on its civil service's professionalism and honest administration, and on the transparency of its regulation. If prosperity is to be maintained, these too must be maintained.

It is important to recognize that economics, and particularly finance, is driven by expectations and perceptions. Even a perceived risk that China is seeking to undermine Hong Kong's autonomy or tamper with the formulas that have made it so successful could severely damage Hong Kong's standing in international financial circles and, by association, its economic prospects.

I stress these points because I am convinced that in the global economy of the 21st century, even more than in the economy of the 20th century, the quality of governance will be a key determinant of prosperity. Capital, skilled manpower and other factors of production are ever more mobile and responsive to changes in the quality of the business environment. And as we move from an industrial to an information era, the degree of freedom becomes an ever more important prerequisite for economic success.

These points bear emphasis. China's actions regarding the Legislative Council and efforts to repeal or amend several key provisions of Hong Kong's civil liberties laws raise some concerns about its appreciation for the fundamental importance of freely flowing information, and for the integrity and autonomy of Hong Kong's economic system.

-- The danger is that, if China handles the transition poorly, if it encroaches or is perceived to encroach upon Hong Kong's autonomy, Hong Kongers have the ability to make such actions extremely costly -- either by leaving Hong Kong (their skills are very welcome elsewhere) or by transferring their funds out of the territory.

This would not only be disastrous for the Hong Kong economy, but the loss to China would be immense: not just in nominal terms, the lost capital and economic strength of Hong Kong, but in terms of potential benefits. For as I've stressed in my remarks, there is much that China can glean from Hong Kong that would aid in its own development.

CONCLUSION

In short, the transition is as much for China to make as it is for Hong Kong. And it is essential that China allow Hong Kong to be Hong Kong. And if there is to be some convergence of systems over time, it would be beneficial for all involved that China's system become more like Hong Kong's than the other way around.

Suffice it to say that the administration will be watching closely how events unfold here, including with regard to how these events affect U.S. interests and our stake in both Hong Kong and China's success.

We at the U.S. Treasury will continue to work with our colleagues in Hong Kong as they maintain their separate economic system. We will continue to meet regularly with our financial counterparts in the context of gatherings of the IMF, APEC, BIS, and as partners in the NAB. We look forward to intensifying our cooperation on matters relating to money laundering and to customs issues. And, further reinforcing the separateness of China and Hong Kong's economic systems, our tax laws will, after July 1, continue to regard Hong Kong and China as two distinct entities for the purposes of U.S. taxation.

I hope that this close attention and interest by the United States in the reversion process is taken in the spirit in which it is given -- out of a profound interest in the health and well-being of both Hong Kong and China, and our relationship with both.

(end text)