# Hong Kong is beating off Shanghai to dominate China's finance



## Monkey (Oct 1, 2002)

Contrary to rumors about its imminent "death" following the transfer of power from the British, Hong Kong has emerged as the financial intermediary through which foreign investors seek to invest tens of billions of dollars into mainland China. Meanwhile, once-booming Shanghai's star is starting to fade. What happened? According to Wharton faculty and other experts, while Hong Kong was crafting a strategy to position the city as both a legal and financial services center for China, Shanghai was weighed down by corruption and a largely state-run financial services sector.



*Out of Shanghai's shadow: Why Hong Kong is becoming China's Financial Services Center*
http://knowledge.wharton.upenn.edu/article.cfm?articleid=1603&CFID=2791595&CFTOKEN=19698621

Published: November 15, 2006 in [email protected]

It's a city-state of seven million people, with skyscrapers wrapped around a picturesque harbor and an in-your-face brand of capitalism. But it wasn't long ago that economic obituaries were being written about Hong Kong: A June 1995 story in Fortune magazine was titled, not-too-subtly, "The Death of Hong Kong."

As the reasoning went, Hong Kong would fade in economic dynamism when the British lease expired and the island reverted to Communist control in June 1997. Under an agreement between Margaret Thatcher's government and China, Beijing vowed to give Hong Kong substantial freedoms, except in foreign and defense affairs, until 2047 -- 50 years after the handover. Observers doubted the hands-off promise, fearing that Hong Kong would become "a captive colony of Beijing ... just another mainland city, governed by corruption and political connections rather than the even-handed rule of law," as the Fortune piece stated. 

At the same time, Beijing's patronage shifted to Shanghai, the gateway to China's interior. According to John Zhang, professor of marketing at Wharton, Shanghai had been the preeminent financial and commercial center in China in the 1920s and 1930s before the Communists came to power, and the city aspired to return to the role. "China had every intention of building up Shanghai as the financial center for all of Asia," he says. 

Yet reports of Hong Kong's death were greatly exaggerated. In a resurgence noted recently by Time's Asia edition and others, Hong Kong has emerged as the financial intermediary through which foreign investors seek to invest tens of billions of dollars into mainland China. Meanwhile, Shanghai's star has started to fade. What happened? According to Wharton faculty and other experts, while Hong Kong was crafting a strategy to position the city as both a legal and financial services center for China, Shanghai was weighed down by corruption and a largely state-run financial services sector. 


*The Favored Child*

As China entered the 1990s, Shanghai was largely untouched by modern ideas of capitalism and political freedoms, thereby making it a more amenable place than Hong Kong for national leaders and economic growth policies. Shanghai also had a powerful political clique pulling strings with Communist bureaucrats. Massive public works projects were started, including a shipping port to rival Hong Kong's. An international crowd gathered in this most Western of mainland Chinese cities, while foreign money in factories, real estate and tech centers flowed in. As one major U.S. newsweekly noted, "Shanghai was the favored child.... Hong Kong was in the shadows." 

"[Shanghai] was the place where capital was to be raised in China," says Marshall W. Meyer, professor of management at Wharton. "In the mid-1990s, there was an assumption that Shanghai would absorb the Hong Kong stock exchange.... Shanghai was allowed to develop its own self-contained economy, like Singapore. Tax policies favorable to Shanghai were developed, and Shanghai boomed."

In response, Hong Kong officials worked to bolster the city's position by emphasizing Hong Kong's rule of law and its British-based court system, anti-corruption measures and U.S.-like securities laws. Officials like Justice Secretary Wong Lan Lung lobbied to make Hong Kong the place to resolve business disputes on both the mainland and in the city itself, an effort that has produced some results. 

Ingratiating itself in Beijing, Hong Kong made an all-out effort to influence Communist leaders so that its needs weren't neglected. And where laws permitted, Hong Kong attempted to integrate itself with mainland China. For instance, Hong Kong officials say they allow thousands of pregnant mainland Chinese women to enter Hong Kong each year to give birth in the city's well-run hospitals. Mainland Chinese banks have expanded in Hong Kong, and both Hong Kong and Chinese currencies are accepted in Hong Kong businesses. Meanwhile, China has scheduled polo events for the 2008 Beijing Olympics in Hong Kong.

Private groups, such as the Better Hong Kong Foundation and the Vision 2047 Foundation, were organized by businesspeople, bankers, asset managers, real estate tycoons and local leaders to promote Hong Kong and address negative perceptions in the West. "The fear was that Hong Kong would be marginalized. At this stage, I can [guarantee] that Hong Kong will not be marginalized," says Vision 2047 member David Dodwell, chief executive of Strategic Access, a Hong Kong consulting company, and co-author of the book The Hong Kong Advantage. Stephen Brown, another Vision 2047 member, in a breakfast meeting with foreign journalists, added: "Shanghai's star is not shining as brightly as it was a few years ago."

Indeed, billions of dollars in foreign investment that might have gone directly to China are now being funneled through Hong Kong, in part because of the Closer Economic Partnership Arrangement, or CEPA, a free trade agreement signed in 2003 between Hong Kong and the mainland. English is widely spoken in Hong Kong, so doing business there is easier for Western companies than in China. In addition, Chinese corporate executives are now seeking to tap robust international capital markets in Hong Kong instead of Shanghai's weaker capital markets. 

One example: In mid-October, China's largest bank, the Industrial and Commercial Bank of China, raised $19 billion in the world's largest initial public offering, dividing the offering between Hong Kong and Shanghai. The share that went to Hong Kong: $13.9 billion. The share that went to Shanghai: $5.1 billion. Other large mainland China banks that have listed on the Hong Kong exchange include the Bank of China and the China Construction Bank. They are among dozens of mainland Chinese companies -- called "Red Chips" -- listed on the Hong Kong exchange, which has internationally recognized regulations.


*A Window to the World*

What caused the reversal of fortunes? Shanghai wasn't ready for the big time, say experts. Its financial services companies -- typically state-run -- and stock brokerages were unsophisticated. Shanghai stock brokerages went bankrupt after promising returns on stocks that tanked. Big-money investors weren't comfortable with weak accounting rules and Chinese market regulation. Chinese laws, meanwhile, restrict the granting of stock options to executives and directors. This has partly encouraged Chinese companies to float stock in Hong Kong through Hong Kong-registered holding companies.

"Most of the listed companies are state-owned. If you are a state-owned company listed in Shanghai you can't give your executives or directors [stock] options," Meyer says. "The Shanghai stock market has been on a long downhill slope for some time ... it also almost looks as if China has outsourced its capital markets to Hong Kong." He notes that the amount of capital raised on the Hong Kong stock exchange in the first half of 2006 -- fueled by Chinese company listings -- was greater than the amount raised in New York. 

Shanghai faces other problems as well. A political backlash in the form of an investigation into local corruption has snared local political bosses. In September, the central government fired Shanghai Party Secretary Chen Liangyu for his alleged involvement in the mismanagement of the city's Social Security fund. Many others are being investigated. It was a stunning political move by President Hu Jintao, who is not from Shanghai and is consolidating national power. "No matter who, no matter how high their post, those who violate party discipline and state laws will receive serious investigation and severe punishment," the state-controlled news agency Xinhua quoted the Community Party Central Committee as saying.

The investigations "already show that Shanghai will not receive the favorable treatment it has in the past," Meyer notes, adding that Beijing wants to prevent endemic corruption. The government has proposed moving local officials around the country to prevent them from building individual political networks. 

Yet according to Zhang, Shanghai still has a big part to play in China's economy. Multinational companies have invested billions in factories and research centers there. Some investment is export-oriented and some is focused on developing local products for the Chinese market. But Beijing also has learned in the last decade that "Hong Kong is a window to the rest of the world.... There is an advantage to keeping Hong Kong prosperous and not overshadowing it." Hong Kong has a deep talent pool of lawyers, accountants, traders, analysts and economists that can't be easily replicated in Shanghai, he adds. 

Mike Rowse, Hong Kong's director general of investment promotion, can barely contain his glee over the Hong Kong bounce. "We found a new lease on life," he says, noting that last year $35.9 billion in foreign direct investment came into Hong Kong, making it one of the world's largest recipients of FDI. Hong Kong doesn't track exactly where all this money goes, but it's believed that a healthy portion is eventually funneled into mainland China, with Hong Kong businesses acting as intermediaries. According to government statistics, Hong Kong entities are the largest external investors in mainland China, accounting for 43%, or $245 billion, of cumulative foreign direct investment.

Hong Kong's economy grew at about 8% last year -- not bad for a mature economy that lost nearly all its manufacturing base over the last 15 years as businesses sought dirt-cheap factory labor on the Chinese mainland. "We don't need the manufacturing," Rowse says. "We do manufacturing where it makes sense to do it.... The manufacturing is never coming back. I have to be careful where I say this in Hong Kong because there are some who still think it will. But it's not." As for Shanghai, he says China is a big country and there is room for both cities to succeed. At the same time, he adds, "people are getting a bit more realistic about what you can do in Shanghai."

With about 90% of its economic output in services, Hong Kong has other issues to deal with. One of its biggest current problems didn't even exist five years ago -- pollution. Favorable breezes act like "down" escalators transporting the smoke of about 200,000 factories in the Pearl River Delta into Hong Kong. American executives complain that they have trouble recruiting and keeping talented managers there because of the smog and air pollution. The 2,000-member American Chamber of Commerce in Hong Kong says U.S. companies have invested $30 billion in Hong Kong, but families don't want to put their kids through a childhood of toxic air.

Todd Hodgson, a vice president with Time Warner, recently recounted to a Wall Street Journal reporter how he relocated his family to Australia from Hong Kong in August. He said his two young children, ages three and six, were constantly in the doctor's office in Hong Kong for asthma and lung ailments. "The money and perks just weren't enough to keep us there anymore," Hodgson said. "You can drink bottled water. But with the air -- you have to breathe it."

Environmental officials in Hong Kong have begun working more closely with mainland Chinese authorities and are posting pollution data on public access web sites. They have also sharply criticized Exxon Mobil for failing to install equipment to clean the smoke from dirty coal-burning electric units that supply Hong Kong with electricity.

"This is part of economic development," Rowse says. "Forty years ago, there were oxygen tanks on the streets in Tokyo. They cleaned it up." Hong Kong can't point its finger at China for air pollution "because much of it is coming from Hong Kong-owned factories. We're not innocent here." As for the threat of pollution to the city's growth, "Individual executives are very critical of the air, but the companies still know they have to be in Hong Kong to earn a profit."


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## Rachmaninov (Aug 5, 2004)

Finally. It's been a long time since I saw an article stressing on Hong Kong's importance. I don't mean that I agree with everything in the article, but it's always encouraging to see some positive news.

If only our own media take a slightly more optimistic view of our city...


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## touchring (Mar 25, 2005)

Well, i just saw news on international financial executives leaving HK due to the air problem.


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## WhiteMagick (May 28, 2006)

Hong Kong is growing 8% because it is benefiting from the booming Chinese economy. Shanghai is already rivaling Hong Kong's port. It has the largest freight volume in the world. And secondly you wouldnt expect a city to overtake Hong Kong in financial services in 10 years. So there is no surprise if Shanghai is not as financially important as Hong Kong. 

Nevertheless Hong Kong is not planned to be China's financial centre. Especially if it still wants to keep the two countries one system policy. It will be strategically incorrect on behalf of the governent. That is why Shanghai is destined to be the financial centre of China. In twenty years Shanghai will be as an important financial centre as Hong Kong.

Needless to say that Shanghai's average GDP growth is around 12%.


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## Siopao (Jun 22, 2005)

I always thought Shanghai was behind Hong Kong's shadow.


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## Monkey (Oct 1, 2002)

WhiteMagick said:


> Nevertheless Hong Kong is not planned to be China's financial centre. Especially if it still wants to keep the two countries one system policy. It will be strategically incorrect on behalf of the governent. That is why Shanghai is destined to be the financial centre of China. In twenty years Shanghai will be as an important financial centre as Hong Kong.


But it's the global financial markets, not the Chinese government, that will determine China's financial centre.


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## Monkey (Oct 1, 2002)

Siopao said:


> I always thought Shanghai was behind Hong Kong's shadow.


Not in terms of hype.


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## staff (Oct 23, 2004)

Shanghai has *just* begun. 
In 20, 50 or 100 years it will be a lot different.


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## Trinity_Spadina (Jun 19, 2006)

Shanghai can only become an important financial centre in GLOBAL stage if rule of law is established in Mainland China, that is something that Hong Kong has advantage over Shanghai, right now Chinese mainland stock markets (both in Shanghai and Shenzhen) are a joke, investing in them is like gambling in casinos, so even high quality state runcompanies are avoiding raising their capitals in domestic market and want to offer their shares in either Hong Kong or stock markets overseas. but who knows this might change in the next 20 years.

Shanghai will still grow in importantce though due to governmental policy and its connection to Chinese hinterland, which no matter how integrated with mainland Hong Kong becomes it still lacks. It's Shenzhen that is having trouble try to re-position itself.


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## Monkey (Oct 1, 2002)

staff said:


> Shanghai has *just* begun.
> In 20, 50 or 100 years it will be a lot different.


But you are still clinging to the "inevitable eclipse of Hong Kong" script. However the article is saying precisely the opposite - that Shanghai's star is fading - that it's already losing its' lustre as a financial centre. The Shanghai clique in China's government, that once awarded favouritism towards Shanghai, are now out of office, and Shanghai's municipal authorities are in the throes of a huge corruption scandal. Of course government favouritism is a mixed blessing. The article points out that government interventionism in Shanghai's financial services sector played a big part in scaring investors away.


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## Lee (Jun 2, 2003)

As The air quality is so bad in Shanghai that it will never be seen as an attractive city for businesses to establish. Afterall, what kind of productivity are you going to have when everybody has lung cancer?


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## feverwin (Feb 25, 2006)

WhiteMagick said:


> Hong Kong is growing 8% because it is benefiting from the booming Chinese economy. Shanghai is already rivaling Hong Kong's port. It has the largest freight volume in the world. And secondly you wouldnt expect a city to overtake Hong Kong in financial services in 10 years. So there is no surprise if Shanghai is not as financially important as Hong Kong.
> 
> Nevertheless Hong Kong is not planned to be China's financial centre. Especially if it still wants to keep the *two countries one system policy*. It will be strategically incorrect on behalf of the governent. That is why Shanghai is destined to be the financial centre of China. In twenty years Shanghai will be as an important financial centre as Hong Kong.
> 
> Needless to say that Shanghai's average GDP growth is around 12%.


I agree all you said except that it should be *One country two system policy*


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## feverwin (Feb 25, 2006)

Lee said:


> As The air quality is so bad in Shanghai that it will never be seen as an attractive city for businesses to establish. Afterall, what kind of productivity are you going to have when everybody has lung cancer?


How do you know Shanghai's air quality is bad? Give me any proof that tells Shanghainese has more lung cancer? Otherwise you are such a disparager!hno: hno:


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## null (Dec 11, 2002)

HK's air quality is no better


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## WhiteMagick (May 28, 2006)

feverwin said:


> I agree all you said except that it should be *One country two system policy*


I sincerely apologise. I got that the other way around! Sorry!


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## hkskyline (Sep 13, 2002)

Monkey said:


> But it's the global financial markets, not the Chinese government, that will determine China's financial centre.


That's not really true. Shanghai has traditionally and historically been China's economic centre, and it makes sense that it will regain that title. There's no point re-establishing another hub in another city. Geographically and economically it doesn't make sense. Add to that the government has a strong favortism over Shanghai, and the foreign investors will have to play by those rules.


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## Kenwen (May 1, 2005)

Trinity_Spadina said:


> Shanghai can only become an important financial centre in GLOBAL stage if rule of law is established in Mainland China, that is something that Hong Kong has advantage over Shanghai, right now Chinese mainland stock markets (both in Shanghai and Shenzhen) are a joke, investing in them is like gambling in casinos, so even high quality state runcompanies are avoiding raising their capitals in domestic market and want to offer their shares in either Hong Kong or stock markets overseas. but who knows this might change in the next 20 years.
> 
> Shanghai will still grow in importantce though due to governmental policy and its connection to Chinese hinterland, which no matter how integrated with mainland Hong Kong becomes it still lacks. It's Shenzhen that is having trouble try to re-position itself.


looks like u dont know the recent stock market in shanghai, the share market this year has over 100% growth, this is a huge growth, the stock at the moment is 2050 points whereas two years ago it was 900 points, shanghai financial power is growing fast as its law and systems are becoming more globalise. I think HongKong still have a chance only if it fully intergrate into china, demolish the stupid border which is a joke, HongKong become what it is today is because it was the only free city in china that accept foreign capital, all the investment from overseas have to went through hk, thats why it become what it is today, but now foreign companies can invest freely the whole china, so hk lost its advantage.


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## Lee (Jun 2, 2003)

feverwin said:


> How do you know Shanghai's air quality is bad? Give me any proof that tells Shanghainese has more lung cancer? Otherwise you are such a disparager!hno: hno:


The proof will happen in 10 years when the cancer is already spread. Every person who goes there and gets off the plane can smell the pollution immeadiately. And I forgot to mention that the water quality there is terrible, filled with metals, including mercury. Mercury will lead to many autistic Chinese children.


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## loureed (Aug 10, 2003)

Don't be ridiculous Lee.


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## rt_0891 (Mar 13, 2005)

The only way Hong Kong can compete with Shanghai ten years from now is to dramatically revamp its tertiary education system, and diversify its economy in order to thrive in other economics sectors. Moreover, the Hong Kong workforce must improve its fluency in Mandarin and English, else it will lose its competitive HR edge.


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## Kiss the Rain (Apr 2, 2006)

Hk in Shanghai's shadow? please, whos the idoit that wrote the article, HK had a huge head start compared to shanghai, HK has always had a greater global influnence even until now, its shanghai thats trying to catch up to Hk, not the other way around!!!
You are portraying to two cities as if shanghai is tokyo and HK is osaka, and osaka is finally going to break the dominance of tokyo, wtf?


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## Monkey (Oct 1, 2002)

Kiss the Rain said:


> Hk in Shanghai's shadow? please, whos the idoit that wrote the article, HK had a huge head start compared to shanghai, HK has always had a greater global influnence even until now, its shanghai thats trying to catch up to Hk, not the other way around!!! You are portraying to two cities as if shanghai is tokyo and HK is osaka, and osaka is finally going to break the dominance of tokyo, wtf?


But it's in terms of hype and future expectations that Shanghai has overshadowed Hong Kong for the last decade. The article makes that perfectly clear even in the first paragraph. The point of the article is to refute that - to show that Shanghai was actually overhyped, that its' star is fading, and that Hong Kong is increasingly seen as China's future no1 financial centre. That is in contrast to the pessimism surrounding Hong Kong's long term future for most of the last decade when it was assumed that Hong Kong's momentum had declined with the opening up of mainland China and that Shanghai would inevitably surpass it.


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## Monkey (Oct 1, 2002)

hkskyline said:


> That's not really true. Shanghai has traditionally and historically been China's economic centre, and it makes sense that it will regain that title. There's no point re-establishing another hub in another city. Geographically and economically it doesn't make sense. Add to that the government has a strong favortism over Shanghai, and the foreign investors will have to play by those rules.


It looks like you didn't read the article. Government favouritism towards Shanghai has dried up. The Shanghai clique have lost power in Beijing and Shanghai's municipal authorities are in the midst of a serious corruption scandal.

And the global financial markets have their own rules. They can locate anywhere they want and they clearly prefer Hong Kong's rule of law over Chinese government regulation in Shanghai. Chinese companies are doing exactly the same. That's why ICBC's recent $19 billion float gave a $13.9 billion share to Hong Kong compared to just $5.1 billion in Shanghai.


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## feverwin (Feb 25, 2006)

Monkey said:


> It looks like you didn't read the article. Government favouritism towards Shanghai has dried up. The Shanghai clique have lost power in Beijing and Shanghai's municipal authorities are in the midst of a serious corruption scandal.
> 
> And the global financial markets have their own rules. They can locate anywhere they want and they clearly prefer Hong Kong's rule of law over Chinese government regulation in Shanghai. Chinese companies are doing exactly the same. That's why ICBC's recent $19 billion float gave a $13.9 billion share to Hong Kong compared to just $5.1 billion in Shanghai.


No, you are wrong, that's because HKers are much more rich than Shanghainese, it's difficult to find another place in the world which has so many rich people in the world living so densely... Maybe New York or Tokyo, too...


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## Huhu (Jun 5, 2004)

Hong Kong is obviously the favoured choice for investors at the moment, it is a mature, secure, and well regulated market. However, it's not like Shanghai is sitting around and doing nothing, the Chinese have more than proven themselves to be competent and independent economic planners. How long it takes for Shanghai to even begin to threaten Hong Kong or even Singapore's position remains to be seen.

Dismissing Shanghai right now is like dismissing New York in the 1800's when compared to London. An extremely myopic view.


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## rt_0891 (Mar 13, 2005)

feverwin said:


> No, you are wrong, that's because HKers are much more rich than Shanghainese, it's difficult to find another place in the world which has so many rich people in the world living so densely... Maybe New York or Tokyo, too...


Ironically, a bulk of Hong Kong's elite are Shanghainese. It may be in their interests to see both cities thrive.



Monkey said:


> It looks like you didn't read the article. Government favouritism towards Shanghai has dried up. The Shanghai clique have lost power in Beijing and Shanghai's municipal authorities are in the midst of a serious corruption scandal.


Take this as an anomaly. Shanghai will always be seen by the CPC as the pearl of its economic revolution. Connections between the People's Congress and Shanghai are just too deep to ignore. On the other hand, Hong Kong is still considered a political outsider in Mainland politics.


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## Tubeman (Sep 12, 2002)

City v City :lock:


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