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

EMBARGOED UNTIL 8:30 A.M. EDT
Text as Prepared for Delivery
May 7, 1997

HONG KONG'S PIVOTAL ROLE IN SHAPING CHINA'S FUTURE

Deputy Treasury Secretary Lawrence H. Summers
Hong Kong Trade Development Council, New York City

INTRODUCTION

Hong Kong never ceases to amaze me. My recent visit to Hong Kong was no exception. I was impressed not only by the city's 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 85 of the world's top 100 banks, and some of the world's shrewdest financial professionals in both the public and private sectors.

As recently pointed out by my colleague and friend, Andrew Sheng, the Deputy Chief Executive of the Hong Kong Monetary Authority, Hong Kong is perhaps the world's leading example of the economy of the future -- a virtual economy -- where services account for about 82% of GDP, as compared to 76% here and 62% in Japan, and the bulk of the manufacturing activity of its firms is done outside its territorial boundaries. It is thus by its very nature, perhaps more so than any other economy in the world, highly dependent on the free flow of information (over 700 newspapers and periodicals are based there), the rule of law and the transparency of the regulatory environment.

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 there, or by the volume of financial flows, but also by number of our citizens whose livelihoods depend on Hong Kong's prosperity.

"Some 36,000 American citizens live in Hong Kong. The 1100 US firms that have invested $14 billion in Hong Kong employ some 250,000 people, nearly 10% of the work force.

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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. And what we are doing to cement the commitment to two systems.

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 -- perhaps, the purest example of an open market economy -- by a society in the midst of transition from a socialist, command economy. What's even more striking, the new sovereign power has made strong commitments that guarantee the continued existence of the 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 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.

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

"Hong Kong is also to retain its status as an international financial center, and its own currency -- separate from the yuan.

Hong Kong's financial and economic civil servants are recognized as world class by their global counterparts. Secretary Rubin and I frequently meet with our Hong Kong counterparts. In my most recent trip to Asia, I met with my Hong Kong counterpart at the Six Markets gathering of finance and monetary officials in Tokyo.

"Thus, the February decision by Hong Kong's Chief-Executive designate, C.H. Tung, 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.

"Hong Kong's foreign exchange reserves are now about $64 billion -- a sizeable cushion against exchange rate instability or shock to the balance of payments.

"The Hong Kong dollar is further backed up by China's pledge to protect it with its own massive reserves of over $100 billion should it come to that.

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

The Hang Seng Index peaked in January at its highest levels since 1994, before following the U.S. market down and then back up again.

It is also noteworthy that Hong Kong's government borrows in Hong Kong dollars at rates nearly equal to those of the United State government for periods of up to two and a half 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. Most recently, China's 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.

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.

"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.

"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.

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

"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.

(r) 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.

"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 (Sheng's virtual economies); and the inclusion of millions of Asians in an unparalleled 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 pointed out for example that Hong Kong borrows at a lower cost that U.S. Treasuries. But if you look further out on the yield curve the markets are saying something less reassuring.

Markets have evaluated the transition developments and preparations favorably and do not expect negative developments in the near terms. But the yield curve starts to rise significantly after two and half years, and by 10 years out the spread over U.S. Treasuries is nearly 80 basis points. This is the market's way of speaking to Beijing. Few predict problems in the short term, but there is wariness about the longer term.

Such wariness is understandable from my visit. I sensed that some believe that politics and economics are somehow mutually exclusive. My impression has been reinforced by a recent decision of the National People's Congress to repeal certain amendments to some Hong Kong laws, including to the Bill of Rights Ordinance and the societies and public order ordinances. This decision has fueled widespread concern in Hong Kong and abroad that Hong Kong's civil liberties and individual freedoms will be restricted after reversion.

On this my message is simple: 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.

A poor handling of the transition would not only be disastrous for the Hong Kong economy, the loss to China would also 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.

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 for China's system to become more like Hong Kong's than the other way around.

HONG KONG RETAINS SEPARATE STATUS IN U.S. POLICY

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

It is reassuring to us that when Vice Premier Qian was in Washington last week he reaffirmed China's commitment to two systems. We are going to take him literally and continue to treat Hong Kong as autonomous economic entity. We will continue to promote a framework of bilateral and multilateral agreements that support Hong Kong's autonomy from China, an objective made clear in the U.S./Hong Kong Policy Act.

The U.S./Hong Kong Policy Act establishes domestic legal authority to continue to treat Hong Kong as an entity distinct from the PRC for certain purposes.

Hong Kong will continue to be treated as a separate partner in trade by the United States. This means that Hong Kong will be retain its separate textile quota; we will maintain separate statistics on our bilateral trade with Hong Kong; and we will negotiate trade agreements with Hong Kong. We have, in fact, just recently signed an air services agreement with Hong Kong.

Hong Kong will also be treated as a distinct entity for the purposes of U.S. taxation.

We will continue to work directly with Hong Kong officials on law enforcement issues --where success depends on [1] the structure provided by bilateral agreements, [2] a significant law enforcement presence, and [3] close collaboration with our counterparts.

"Last month, we signed a prisoner transfer agreement and a mutual legal assistance agreement with Hong Kong. A U.S./Hong Kong extradition agreement which was signed earlier is now before the Senate for its advice and consent to ratification.

"Our enforcement presence has been expanded in recent years with additional FBI and INS officers stationed in Hong Kong and the opening of an office of the Secret Service in Hong Kong last year. There are no plans to reduce this presence.

"Finally, in the realm of enforcement, we at Treasury look forward to continuing and intensifying our close collaboration with Hong Kong authorities on a wide array of efforts to fight organized crime -- narcotics trafficking, money laundering and smuggling.

As I noted earlier, our people and our enterprises have strong ties with Hong Kong. Reflecting the breath and depth of our relationship with Hong Kong, our Consulate in Hong Kong is one of our largest in Asia, with over 140 direct-hire U.S. officials and a dozen separate USG agencies.

"Negotiations with the government of China to maintain our Consulate General in Hong Kong, after July 1, have been concluded. We have successfully reached an agreement with no limitations on size of our Consulate or existing operations.

"We are, in fact, discussing within our government the possibility of stationing a Treasury official in Hong Kong to more closely manage our growing financial relationship with Hong Kong and the region. This would be our only presence in Asia outside of Tokyo.

Reinforcing its role as a separate player in the financial arena, we will continue to support and encourage Hong Kong's participation in the multilateral financial institutions and organizations. Hong Kong has ensconced itself well in the international financial system. These are moves that China has supported. Hong Kong is a participant in the New Arrangements to Borrow established by the international financial community last year. It was among the select few recently invited to join 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.

CONCLUSION

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. And we will continue to deliver our message that there is no fire wall between economic and other freedoms.