Hong Kong under Siege

The city is losing its advantages

Airlines do it. Cola companies do it. But when cities launch multimillion-dollar rebranding campaigns, it's a sure sign of a brewing identity crisis. In late May, the Hong Kong government unveiled a new logo featuring a stylized dragon and a slogan that sounded old before its time: "Hong Kong--Asia's World City." The campaign's aim was to set the former British colony apart: to remind the international business community that Hong Kong is not just another Chinese metropolis. But for many of Hong Kong's 7 million residents, the move seemed more like an act of desperation.

In fact, the administration of Chief Executive Tung Chee-hwa is plenty worried. After weathering the Asian crisis, official Hong Kong is biting its nails as the city steadily loses its competitive advantage. "With the mainland changing and growing so fast, we have to compete for shelf space," explains newly appointed Financial Secretary Antony Leung. He adds: "People see that our cousins in the north are moving faster than us."

Therein lies the great irony: As Hong Kong enters its fifth year as a Special Administrative Region of China, the motherland, besides being the city's No. 1 partner, is increasingly its greatest competitor, too. With cities from Shanghai to Beijing to Shenzhen vying for a piece of the action, Hong Kong is losing its monopoly on China trade. No longer is it the sole provider of such services as financial consulting, product design, advertising, and marketing. And the government often seems more concerned about protecting entrenched interests than promoting a cathartic break with the past.

Signs of the challenge are everywhere. Multinationals such as Compaq Computer Corp. and IBM are moving people or operations across the border. Chinese industrial giants are tapping the Shanghai equities market instead of the Hong Kong Stock Exchange. Hong Kong's pollution and high costs have undercut its appeal as a place to live and work. And China is closing the infrastructure gap, having plowed billions into ports, roads, and telecom.

Moreover, Hong Kong's position as a Greater China hub is under threat. With 300,000 Taiwanese working on the mainland and with direct air and shipping links across the Taiwan Strait expected soon, Hong Kong could find its role as middleman between Taiwan and the mainland eliminated. "Hong Kong is no longer the mandatory launching pad," says Gordon Orr, a McKinsey & Co. managing director. Orr should know: Last year, he moved the consulting firm's Greater China operations from Hong Kong to Shanghai.

BODY BLOWS. To be sure, Hong Kong isn't about to fade into oblivion. With China predicting that its economy will grow 7% a year for the next decade, Hong Kong's slice of the pie, though shrinking, should still be considerable. While China's accession to the World Trade Organization will mean more companies going to the mainland directly, the Tung administration insists WTO membership will give Hong Kong a short-term lift. And despite absorbing body blows since the handover, Hong Kong's legal system and civil freedoms remain in place--a matter on which Tung was eager to reassure President George W. Bush during a mid-July visit to Washington.

Finally, there is Hong Kong's fabled resilience. "Hong Kong has been able to reinvent itself so many times," says Robert E. Adams, executive director of CITIC Pacific Ltd., the Hong Kong offshoot of one of China's largest companies. "It always seems to find a way."

But can the city reinvent itself this time? Never before has Hong Kong faced competitive pressure on so many fronts. All sorts of things--from salaries to rents to feng shui experts--are cheaper on the mainland (table). The city remains the world's No. 1 port, but even in this regard the mainland is becoming a force. Since 1996, the port of Shenzhen has boosted the number of containers it handles sixfold, to nearly 4 million a year. And the rapid development of mainland stock markets is putting the Hong Kong Exchange in the shade (chart). Last year, 230 companies listed in China. By comparison, only 43 listed on Hong Kong's big board, and just 5 have done so this year.

What's more, having established their credibility by listing in Hong Kong and New York, Chinese heavyweights PetroChina Co. and China Petroleum & Chemical Corp. are heading back to the mainland for cash. Each is tapping the Shanghai market with billion-dollar offerings, taking advantage of much higher valuations in the mainland market. That means the fat underwriting fees for such deals will not go to Hong Kong securities houses but to Chinese firms.

While the troubling corporate defections don't amount to an exodus, some big names are starting to shift their operations. Take HSBC Holdings PLC, Hong Kong's foremost bank. It is moving 1,200 back-office jobs to neighboring Guangzhou to take advantage of lower costs. For its part, Hong Kong apparel maker Giordano based its international IT operations in Guangzhou and named a mainlander to head it up. "We've found this team much more effective than the previous setup in Hong Kong," says Giordano President Peter Lau. "I suppose it is the devotion to their work, as opposed to the Hong Kong staff, whose focus was almost entirely on short-term pay." Now, Hong Kong IT employees go to Guangzhou for training, a serious comedown.

Without incentives to stay, the trickle of corporate departures will continue. Right now, express package giant DHL Worldwide Express Inc. bases its regional operations at Hong Kong's Chek Lap Kok airport. But the company is eyeing a move to nearby Shenzhen, where airport fees and labor and property costs are a fraction of Hong Kong's. DHL is also weighing a joint venture with either Hong Kong's Cathay Pacific Airways Ltd. or a mainland carrier to set up a regional hub. "If we don't get a more favorable cost position [in Hong Kong]," warns Ross Allen, operations director for Asia-Pacific, "we won't be investing here." At the same time, mainland airports handle almost as many flights to and from the U.S. as Hong Kong does, so it's easy to go directly to Shanghai or Beijing.

It's not merely a matter of saving money: Often, it just pays to be closer to the action. Investment house CLSA Global Emerging Markets, for example, is moving its equity team from Hong Kong to Shanghai. "China is now more open," says CLSA Chairman Gary Coull. "Information is more accessible than ever--and gets more so every day." He notes that there are 615 companies listed in Shanghai and 505 in Shenzhen, adding that "the closer you are to the source, the better the information you get." And when China joins the WTO in the next few months, more finance companies will follow CLSA's lead--as China is forced to open its securities markets to foreign interlopers.

TOP-NOTCH. For his part, Alcatel Asia Pacific President Ron Spithill has been running things from Shanghai since last year. "We chose Shanghai as a place with the most powerful vision in the region to be a leading center of technology," he says. Spithill also lauds the city for aggressively wooing foreign companies and providing top-notch infrastructure.

Not long ago, few executives would have considered giving up their comfortable lives in Hong Kong. Today, China's big cities boast amenities that would have been unimaginable a few years ago. Stores and supermarkets sell everything from Brie to dental floss. Shanghai's branch of the American Chamber of Commerce is one of the world's fastest-growing, as more senior executives make the move north from Hong Kong. "Five years ago, executives wouldn't locate to Shanghai because of the quality of life," says Frank Martin, president of the American Chamber of Commerce in Hong Kong. "Today, they have a fine American Club, great golf and recreation--it has made a difference."

Next to China, Hong Kong sometimes looks as if it has been standing still. Despite government moves to clean up the city's air and water, the environment continues to give foreign companies pause. One is Walt Disney Co., which aims to open a $1.8 billion theme park by 2006. "We hope to see the environment improve [by then]," says Steve Tight, managing director of Hong Kong Disneyland. Hong Kong ranks 69th out of 215 cities in the William M. Mercer consulting firm's World-Wide Quality of Life Survey--behind New York, London, and Sydney, all of which made the top 10.

While Hong Kong's greatest resource has always been its people, the schools continue to turn out rote thinkers who speak lousy English. The situation is only expected to worsen as more schools switch to mother-tongue instruction. Of 387 teachers and staff recently tested for written English fluency, just a third passed. Even top universities underwhelm. "These students are just not stacking up," says an exec at a U.S. investment bank.

In some ways, Hong Kong's financial markets also risk falling behind those of the mainland. Regulators across the border are moving rapidly to make China's markets less like a crap shoot. The mainland will introduce quarterly reporting next year, while Hong Kong only requires semiannual reporting. A landmark securities law that would criminalize insider trading in Hong Kong has languished for a year. David Webb, a shareholder activist and editor of Webb-site.com, blames entrenched interests. He says Hong Kong risks becoming the "financial backwater of China" if it does not improve corporate governance.

It's not as though the Tung administration is sitting idly by. For instance, it is trying to get more out of Hong Kong's most prized asset, its deep-water port. In response to rapid development of container handling facilities in Guangzhou, the Ports & Maritime Board is staying ahead of the game by providing sophisticated just-in-time delivery for the likes of computer assemblers. On the environmental front, the government is forcing diesel taxis to switch to cleaner fuels, and has initiated talks with Guangdong province to tackle cross-border pollution. It also has set in motion educational reforms that are supposed to foster creative thinkers.

PRICEY. But staying competitive will require bolder moves from a bureaucracy and an elite that have become complacent over the years. For starters, the government needs to loosen immigration laws to attract IT engineers and managers from the mainland, a controversial matter in a city where unemployment is stuck at 4.6% and the economy is expected to grow 1.5% this year. Opening the border 24 hours a day also would further integrate the city with Guangdong, forcing competition on monopolistic retailers and bringing down prices in a city that is still one of the world's most expensive. And to develop Hong Kong as a regional air hub, the government will have to pursue an open-skies policy that allows carriers to pick up more passengers in Hong Kong.

Above all, Tung will have to make choices that will hurt the city's various business lobbies. If Hong Kong doesn't start making some serious progress soon, its rebranding exercise will be an expensive waste of time.

By Frederik Balfour and Mark L. Clifford in Hong Kong

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