Hong Kong's International Financial Centre: Retrospect and Prospect

If China’s transition goes smoothly and full currency convertibility comes reasonably soon,
Hong Kong’s macro-policy settings could still be broadly maintained but the key currency in the
linked exchange rate mechanism would be the RMB and not the US dollar. Even after Hong
Kong is fully integrated into greater China, its IFC could and should retain some ‘room for
maneuver,’ some relative autonomy within an evolving union. Its continuing success would
depend on developing certain niches, certain sub-specialties within more complex global and
national financial markets. It would depend on developing durable linkages between financial
intermediaries that remain based in Hong Kong and greater China’s real economy.
Another way to imagine this most plausible future is to go back to Mundell’s trilemma.
The smoother and the more rapid China’s transition to currency convertibility and an open
capital account, the faster Hong Kong’s IFC will have to adjust away from the traditional notion
of a simple gateway into and out of a relatively closed Mainland. Since it is implausible to
imagine that in a post-transition environment the Hong Kong dollar would be freely floating visà-vis
the RMB or that Hong Kong’s capital markets would be less open, then its monetary policy
would have to be fully subordinated to Beijing’s. At that point, the idea that Hong Kong would
be the London of the region also becomes implausible. What then might be the sources of any
competitive advantages that could promise a high degree of prosperity?
The logic leading to such a question poses a deep challenge—because its answer is so
obvious. Perhaps there was a time, say, in the decade before the crisis of 2008, when some may
have imagined a ‘global’ city disconnected from a diversified economic base and building a
secure prosperity on the specialized foundation of a super-efficient financial sector serving
markets around the world. The crisis and its continuing resolution, however, reminded us all that
durable competitive advantages, as well as adequate fiscal backstops, rest on ‘real’ economies
and strong-enough polities. Such economies, like the North American one on which New York
depends or the European one on which London, Frankfurt, Zurich, and Paris depend, include a
diversified industrial base, large consumer markets, and long-term investors unable or unwilling
to flee in an emergency. Not coincidentally, such an economy is the source of fiscal capacity,
the kind of capacity absolutely required during a financial crisis. To prove the point, think about
the recent experience of Iceland. A financial sector disconnected from a robust real economy
can thrive only in the short run.
Much of the early literature on Hong Kong as an international financial centre implicitly
rested on the assumption that the world economy was inexorably moving ‘beyond borders.’
Perhaps such a belief will once again become plausible. I hope so. But today it seems a risky
guide for policy. Certain images of Hong Kong’s future, drawn imaginatively from the history
cited in the opening pages of this study, seemed quite believable ten years ago: images of the city
as a laissez-faire financial metropolis, as a durable global meeting point resting on a fluid and
entrepreneurial culture, or as a secure centre for the regional headquarters of corporations based
elsewhere in the world. Such images deserve intensive and skeptical scrutiny today. They
justified ultra-low tax policies, ever higher foreign exchange reserves, unusual patterns of land
ownership and land use, and constrained social, public health, technology, and education
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