Drawing A New Map

Is intervention the right way to save the manufacturing sector?

If Hong Kong were the type of Asian Tiger where manufacturers are king, Patrick Wang Shui Chung would be among the glitterati . As chief executive of Johnson Electric Holdings Ltd., the Purdue University graduate has turned his family's $350 million company into a world leader in micromotors, the tiny devices that power everything from hair driers to car locks. Wang is up on the trendiest U.S. management concepts, has wired his factories and research labs to the hilt, and has even redesigned Johnson's once dumpy headquarters in a motif that could be described as post-industrial: lots of airy white cubicles separated by glass, steel, and oxidized copper plates.

But as his chauffeured blue Mercedes 500SEL pulls out of Tai Po Industrial Estate, a gritty old factory enclave, Wang knows only too well where Hong Kong's real action lies. Emerging from a cross-harbor tunnel, his car glides past forests of gleaming towers jammed with some of the world's priciest offices, shopping malls, and condominiums. To the right, vast chunks of Victoria Harbor are being filled in for more skyscrapers. As an industrialist, Wang says, he and his wife are ribbed at dinner parties by other Hong Kong tycoons who have made easy fortunes in property and finance. "They tell me I'm becoming irrelevant," Wang says. "Sometimes I wonder if they are right."

For good reason. Manufacturers such as Wang now account for just 9% of gross domestic product, vs. 24% in 1980. The real business celebrities are billionaire developers such as Li Ka-shing and Cheng Yu-tung, who profit from Hong Kong's role as East Asia's premier hub for trading, finance, shipping, and media. Over the past two decades, Hong Kong's service sector has grown an average of 17% annually, twice as fast as in other Tigers.

Hong Kong's economy is so vibrant, in fact, that many business leaders question whether it needs manufacturing at all. Optimists believe that if Hong Kong holds taxes low, maintains top-notch facilities, and keeps government out of the way, it will thrive on services and entrepreneurial wizardry alone well into the 21st century.

That cozy, conventional view is under fire as never before. There is growing fear that the laissez-faire style that worked for British overlords may not see Hong Kong through the rapid shifts roiling the global economy. The reason is that some 45% of services still revolve around manufacturing, including the many goods that Hong Kong companies now produce in low-wage factories in South China. If this production base erodes, services such as trade finance, shipping, and design could slump, too. Having a vast labor pool across the border may not be enough. Analysts say rising costs are eating away at South China's competitive edge in cheap assembly industries. And a shortage of skilled workers will make it tough to move up the ladder to more sophisticated goods.

The proposed remedy is to bring industrial policy to Hong Kong. While the squeeze on manufacturing hasn't hit the economy yet, a growing circle of industrialists, academics, and close advisers to Chief Executive-designate Tung Chee-hwa says Hong Kong must act to preserve and even enhance its prowess in manufacturing. Reaching that goal, they argue, will require government help because of Hong Kong's astronomic property costs and anemic spending on research and development. Already, other Tigers such as Taiwan, Singapore, and Malaysia are luring big investments in leading sectors such as semiconductor design, multimedia software, and biotechnology through a blend of investment incentives, support for R&D, and subsidized industrial parks.

Such mixing of government with industry would be a radical departure for Hong Kong. The topic raises the delicate issue of whether, if at all, Hong Kong should coordinate planning with China. The notion is highly contentious among the property developers, traders, financiers, and senior civil servants who dominate the business scene. Says Hopewell Holdings Ltd. Managing Director Gordon Y.S. Wu: "If it ain't broke, don't fix it".

NERVE CENTER. But then, the words "laissez faire" aren't chiseled into any of the agreements Beijing and London have negotiated for the city's future. To visionaries, that means Hong Kong can rejigger its economic model. The end of British rule also could make it easier for Hong Kong to link its economy more smoothly with that of the Pearl River Delta, a region of 20 million. While the manufacturing base is effectively integrated, many businessmen have chafed at the utter lack of coordination between the governments of Hong Kong and bordering Chinese cities when it comes to airports, railways, and highways. "We have the opportunity to revisit everything in Hong Kong," says textile tycoon Henry Tang Ying-yen, Tung's top industrial adviser.

To be sure, nobody advocates the heavy-handed industrial policies used by Japan, South Korea, and Singapore, where huge bureaucracies actively try to pick winners and losers. Even the interventionist club rejects trade protection, administrative "guidance," and lavish subsidies of, say, silicon-wafer fabrication.

Rather, the idea is to make investments that enhance Hong Kong's role as the sales, service, and product-development nerve center for Asian goods. Moving beyond cheap assembly goods is hard now because of Hong Kong's R&D spending of just 0.1% of GDP and high costs of industrial land and staff housing. Plus, the Pearl River Delta's scientific and technical talent pool is poor compared with that of coastal cities such as Shanghai, Tianjin, and Qingdao. Unless Hong Kong develops leading-edge knowhow, frets Executive Director York Liao of liquid-crystal-display maker Varitronix Ltd., "we may hit an economic plateau."

So far, no master plan has emerged. But Tung's transition team is weighing a raft of ideas (table, page 43). They include setting aside land for research parks, export processing zones using Chinese contract laborers, and affordable housing for expatriate managers. Another common element is helping to upgrade the Pearl River Delta's industrial base, either with new estates bordering Hong Kong or technology tieups between universities.

Adding heft to both sides of the debate are two books that Hong Kong trade groups commissioned from U.S. academics. The Hong Kong Advantage, from a team led by Harvard business school's Michael J. Enright, argues that Hong Kong can continue to thrive just by upgrading its service sector. Made in Hong Kong, by a team of Massachusetts Institute of Technology faculty led by Suzanne Berger and Richard K. Lester, doubts that Hong Kong's model is sustainable (box).

The basic question is whether Hong Kong's entrepreneurs really need the help. The city's role as a one-stop shop for the world's garment trade is a case in point. It's where buyers congregate to find suppliers of any garment imaginable, and where a manufacturer can get any kind of sample sewn in days. Big Chinese factories are a few hours away by jetfoil. Give a concept for a new clothing line to outfits such as Li & Fung, Esquel Enterprises, or TAL Apparel, and they'll take it from there, from design to just-in-time delivery to a U.S. retailer.

Esquel Chairman Marjorie Yang thinks her company proves why help isn't needed. From its 300-worker Hong Kong office, Esquel manages a global network of factories that make shirts for labels such as Tommy Hilfiger and Brooks Brothers. Whether the shirt is sewn in Madagascar, Jamaica, or northwest China, Esquel can promise a New York buyer the same quality at the same time at the same price. It also handles designs and develops fabrics. "There's really no reason to think we will lose our competitiveness because manufacturing isn't done in South China," says Yang. "It's people, good management, and hustle that make the difference."

But Harry N.S. Lee, whose TAL churns out $525 million worth of garments a year in five Asian countries, disagrees. He considers his 1,000-person Hong Kong plant vital. It's where TAL whips out orders for high-end clients such as Giorgio Armani, pioneers new production processes, and perfects its sophisticated computer network for just-in-time delivery. But with Hong Kong's tight labor market, staff turnover is around 5% per month. Lee thinks the government should increase Hong Kong's supply of foreign laborers and set up a manufacturing zone near the border employing contract workers from China.

In higher-tech industries, Hong Kong's plight is more pronounced. Johnson Electric's Wang says his big problem is keeping top-rate engineers, many of them recruited in Europe and the U.S., to design micromotors for clients such as Hewlett-Packard Co. and Black & Decker Corp. The motors are produced by 13,000 workers in Hong Kong and China.

BITTER AND ANGRY. With ho-hum Hong Kong apartments renting for $10,000 a month, Wang says it is more than twice as cheap to employ an engineer in California. He warns that unless Hong Kong contains costs, companies such as his will have to move R&D operations--and inevitably their factories and support staff--to northern China or even the U.S.

The most serious danger isn't losing well-managed companies such as Johnson Electric and TAL. A bigger peril is the lack of forward thinking by the vast majority of Hong Kong manufacturers, who invest little or nothing in R&D and staff training in Guangdong. Instead, they rely on young laborers from China's interior who go home after a few years. This workforce lacks the machinery skills needed for making more advanced products. And rather than develop strong local managers, most companies send staff from Hong Kong to run assembly lines, handle personnel, and control quality. With little chance of rising to the top, says Berger, "many lower-level Chinese managers are bitter, angry, and prepared to jump."

With costs in the Delta rising 15% to 20% a year, most manufacturers simply shop for cheaper labor elsewhere in Asia. But the farther they go from Guangdong and its Cantonese culture, the study found, the harder it is to get Hong Kong managers to move.

There's also fear that Hong Kong's control of the China trade isn't guaranteed, as industry and facilities improve in port cities to the north. Inevitably, services such as trade finance, insurance, and logistics will develop in the north as well. To keep trade flowing through Hong Kong, the pro-industry camp thinks it's important to have manufacturing close to home. Bolstering local product design is considered key. The government has made a modest start. There is a facility for high-tech startups, a 22-hectare site for a science park, and the new Hong Kong University of Science & Technology. "This is a drop in the bucket," says HKUST President Woo Chia-wei.

TIME WARP. Woo thinks adherents to Hong Kong's minimalist system are in a time warp. "They still see Hong Kong as an enclave, an outpost on the periphery of the empire," he says. "The way I look at it, Hong Kong will be the dragon head of one-third of China." At HKUST's stunning cliffside campus overlooking the South China Sea, it's clear that Woo is thinking big. Most of the faculty are ethnic Chinese scientists lured from premier Western universities.

Tellingly, HKUST hired Otto C.C. Lin as vice-president for R&D. Lin is a former president of Taiwan's Industrial Technology Research Institute, the lavishly funded government body employing thousands of scientists working on next-generation technologies. While he agrees that a similar research institute wouldn't fly in Hong Kong, Lin believes that "without any support for R&D, industry in the Delta will slowly twist in the wind" while Singapore, South Korea, and other Chinese provinces sprint ahead.

C.H. Tung's transition team agrees. Industry adviser Tang, for one, suggests building industrial and housing estates for multinational headquarters on lightly inhabited Lantau Island, site of Hong Kong's new airport. He also thinks the government can tap its $60 billion in reserves to finance a venture-capital fund for high-tech startups and help develop infrastructure in Guangdong.

That's exactly the kind of talk that sets off alarm bells among free marketeers, who fear that government intrusion will only screw up a good thing. To Li & Fung Managing Director William K. Fung, the real issue is how to use Hong Kong's limited land. Already, he says, industrial estate tenants pay a fraction of the more than $100 a square foot that commercial space fetches on the outside. Yet most "manufacturers" use most of that cheap space for offices. If Fung had his way, industrial land would be converted to commercial use, where it is more desperately needed. "We shouldn't subsidize these companies at all," Fung says.

Senior civil servants have the same doubts. They fear that once the government favors one business sector, Hong Kong's level playing field will be ruined. Finance, media, and advertising also can argue they are vital. "Once you start intervening, where do you stop?" asks Director-General for Industry Francis Ho.

Some free marketeers think the issue will disappear as Hong Kong eventually melds with South China. Hongkong & Shanghai Banking Corp. economist George S.K. Leung thinks Hong Kong and South China will become one big metropolis. As Guangdong develops, it also will move on to services, and labor-intensive manufacturing will migrate to China's hinterland. Hong Kong will still thrive as a base for planning, finance, and marketing. "Nobody distinguishes New York from the rest of the U.S.," says Leung.

But even on this point, issues remain. True, Hong Kong business executives agree that the next government should work more closely with China on matters such as infrastructure planning. Because that wasn't done under the British, there now are four major airports within 30 miles of each other, railways and expressways don't link up, and there is only one narrow border crossing. On bad days, trucks moving goods from China to Hong Kong's port wait up to 15 hours for customs clearance.

With the handover, coordination becomes easier. But how close should the relationship be? Hong Kong leaders want their infrastructure to be superior to anything across the border. Otherwise, the city could lose its special value--and political leverage--with Beijing. Another fear is that once China's bureaucracy is consulted, public projects will become ensnarled in Beijing politics.

Such anxieties will moderate any impulse for Hong Kong to veer too far from its usual market approaches. But with government now in the hands of leaders looking at the long term, industrial policy will no longer be taboo.