Once people risked all to get in – now they are queueing up to escape. Hard times in Hong Kong have made China the new Mecca

For days and days it had rained, but nothing could dampen the spirits of the millions of Hong Kongers, and hundreds of thousands of tourists, who came to witness the handover of Hong Kong to China. It was June 30, 1997, and the British laid on a firework display to remember as Chris Patten, the last governor, boarded the royal yacht Britannia and made his exit. The next night the Chinese staged an even more stunning display across the water that divides Hong Kong island from the Kowloon side. Hong Kong was engulfed in optimism – on June 30 about the past, and on July 1 about its future. The only doubt that lingered, along with the whiff of gunpowder, was what the Chinese might do with their new possession.

But any such doubts failed to cast even a faint shadow over the partying. The British were too busy declaring what superb colonial masters they had been. The Hong Kong Chinese, whose living standards had rocketed in two decades, eyed their new masters with a touch of anxiety but believed the party would go on for ever. The gleaming steel-and-glass skyline of Hong Kong island, one of the architectural wonders of the world, symbolised this confidence, the local ego boosted by western praise of its industry and acumen, fuelling an arrogance towards those around it.

In the event, everyone was wrong. This small territory, swallowing every scrap of propaganda about its economic invincibility, was standing on the edge of its own nemesis. With hindsight, the warning lights were already starting to flash. The day after the handover, the Thai baht went into free fall, triggering the Asian financial crisis. That autumn, the Hong Kong dollar came under huge speculative pressure and the stock market, once No 4 in the world, crashed.

But the boat never capsized. Property prices took a dive, retail prices stagnated, but hardly anyone thought it would be long before normal service was resumed.

Five and a half years on, Hong Kong’s population of almost 7m is in shock. The past ended in 1997; the future never happened. Ever since 1997 it has barely experienced any economic growth. The consumer price index (which includes housing rentals) has fallen for more than 50 consecutive months, tantamount to a decline of 12% in five years. Hong Kong is living through the worst deflationary spiral of any country since the second world war. Prices for residential property have fallen by 65%, commercial property by 70%. A small two-bedroom flat bought in 1996 for HK$4m would now sell for around HK$1.2m (sterling is worth about HK$12). Unemployment, for two decades virtually nonexistent, is now more than 7%.

A vicious price war has broken out between the supermarket chains, with the price of a rice box, staple diet for the locals, falling from HK$20 to less than $10. Almost 100,000 families, that is 8% of homeowners, find themselves in a position of negative equity with no end in sight.

The banks used to claim that personal debt would never become a serious problem in Hong Kong because it carried such a stigma among the Chinese. A visit to the High Court soon dispelled that illusion. Court No 9 was filled with people attending a self-bankruptcy hearing. The official read out eight names at a time, the defendants standing as their name was called, until some 40 people had been declared bankrupt in one half-hour sitting. In 1997, 679 were declared bankrupt; in 2001 it had risen to 9,151; by the end of October last year the figure was 20,204, the vast majority because of an inability to pay credit-card bills. The weekly tally of bankruptcies is now almost as large as that for the whole of 1997.

Fanny Wong, a smartly dressed woman in her late forties, fought back tears as she told her story. Her husband lost his job at a country club and was unemployed for three months until he found a job in security for half the wage he’d previously been earning. He complained that it was impossible to get work in hotels or restaurants at anything like the same wage as before, because young mainland Chinese could be employed for much less. The Wongs, who live in a public flat on Hong Kong island with their 13-year-old daughter, found it impossible to make ends meet. ‘We can’t pay the debts. I tried to kill myself, but I didn’t want to upset my aged mother. I had to declare myself bankrupt. It is the worst day of my life.’ The fact that debt has been taboo in Chinese society makes bankruptcy an even more humiliating experience.

For some, life is even more precarious. So Yuk On, 47, with a wife and five-year-old daughter, has a friendly, cherubic face and gives the impression of being comfortable with the world. In reality he is hanging on by his fingernails. Hong Kong is the most unequal of all the developed societies in the world. This means there are many like So Yuk On, their plight largely ignored in a country where there is no unemployment benefit, little public assistance and no pension. For those already living on the margins, the downturn in Hong Kong’s fortunes threatens personal catastrophe. So Yuk On lives with his family in one small room, built illegally on top of a high-rise building.

For more than 15 years he has worked as a chef. ‘I used to earn HK$15,000 a month, then this got cut to HK$12,000. For the last three years I haven’t been able to find a full-time job. I do casual work now, whatever I can get, working 11 hours a day and earning HK$4,000 a month. It’s definitely not enough to live on.’

So what has gone wrong? Have the Chinese messed up, as the West kept warning they might? Have they been too heavy-handed with their new acquisition? Meet Allen Lee, a short, rotund, bespectacled dynamo of a man, who until recently was chairman of the neo-Thatcherite Liberal party and who amassed a fortune making circuit boards. He’s the kind of guy who is equally at home in the Legislative Council (of which for many years he was a member), wheeling and dealing in electronic trading, hosting his phone-in radio show, or bargaining at a local night market. He is a very Chinese phenomenon. ‘No one anticipated this situation in 1997. When China took over, it was a joyous occasion. The only concern was whether it would interfere too much in the administration and the rule of law. I take my hat off to China. They did not interfere with Hong Kong – the people don’t feel they have.’

In fact, the Chinese have acted with great restraint. It would be hard to think of another country where a transfer of sovereignty has been accompanied by so little overt change. It took well over a year for Chinese flags to appear, and then only very few. The People’s Liberation Army is nowhere to be seen. Most of the old colonial arrangements are still in place. China’s behaviour has, by any standards, been exemplary, even though a certain nervousness persists, as exemplified by the present arguments about the introduction of a new law on sedition. But despite the fact that China has belied all the critics, it is still, by a strange twist of fate, responsible for the headlong descent of its proud new possession. In 1978 China slowly began to introduce market reforms. It was the beginning of 25 years of breakneck economic growth. And Hong Kong reinvented itself as the gateway to China. Virtually all Hong Kong’s manufacturing capacity decamped over the border to take advantage of China’s far lower labour costs. Hong Kong, instead, became the front office for China, the port through which China’s growing exports were channelled, the financial centre for dealing with China, the place where western and Japanese multinationals set up regional headquarters from which to explore a forbiddingly unfamiliar Chinese market. Hong Kong was in the right place at the right time. Hong Kong got lucky.

When a country is on a roll, people offer all sorts of reasons for its success, both true and false, many of which serve to feed illusions and ego, so that when history tacks and the wind goes out of a country’s sails, it finds the adverse turn of events hard to accept and even harder to adjust to. The Cantonese were extolled for their industry, flexibility, resourcefulness and risk-taking. Hong Kong was acclaimed for its free-market principles and low taxation. Few mentioned luck.

Success came to be seen as part of Hong Kong’s way of life, its birthright. In fact, for two decades (arguably much longer) Hong Kong’s prosperity was largely down to luck – its relationship with China. By the late 1980s, intoxicated with its own virtue, this rising prosperity took leave of its senses and turned into an asset bubble, a hugely absurd one, rivalling that in Japan in the late 1980s and that in the United States in the late 1990s.

Property has long been the main source of wealth in Hong Kong: for the old British firms like Jardine, for their Chinese successors and for the third of the population that bought into the property market. During the 1990s, property reached crazy levels until the bubble burst soon after the handover and prices tumbled. The collapse in property prices has perplexed and traumatised the middle class. Two generations have grown up believing that property only goes up, with a trajectory resembling that of a rocket.

Now, as prices fall back to Earth, the optimism of the middle class has been shattered. Pressed by this mood of desperation, the government keeps on inventing new schemes to shore up the market, with precious little effect. And for one obvious reason: the cause of the collapse lies elsewhere.

For more than two decades, Hong Kong enjoyed a virtual monopoly as the gateway to the world’s largest market to its north. At the time of the handover, few doubted that this state of affairs would continue; indeed, it appeared that Hong Kong’s position would be enhanced by Chinese sovereignty. People spoke of a win-win situation: as China grew, so Hong Kong would benefit.

The reality has been very different. As China has increasingly opened up, Hong Kong’s monopoly position has been progressively undermined, a key moment being China’s membership of the World Trade Organization in November 2001. Who needs to use an offshore front office when you can establish a new one onshore in any Chinese city? Western and Japanese firms are increasingly bypassing Hong Kong in favour of mainland cities like Shanghai.

Hong Kong now has to compete with China. Its bloated cost structure, driven by an insane property market deliberately created by the British, has become Hong Kong’s albatross. Until recently the most expensive city in the world, Hong Kong can no longer afford to be Hong Kong. The former colony is nervously eyeing its rivals to the north: Shanghai has been getting huge flows of foreign investment and in the medium term threatens Hong Kong’s position as a financial centre, while Shenzhen, a stone’s throw from Hong Kong, is rapidly challenging the latter’s position as the world’s largest port and as a place to shop. The party is over. Just as surely as Hong Kong got lucky, it has now got unlucky.

It has taken Hong Kong five years to begin to acknowledge this. Virtually everyone believed that the property crash would soon be reversed and nirvana restored. It never was. Prices have continued to fall. Now people have stopped hoping, though few recognise the true dimensions of the crisis. When history changes direction, it takes a long time for the implications to be understood. Hong Kong is still a land of illusion.

The financial community has been one of the purveyors of illusion. Constantly acclaiming Hong Kong’s virtues as a free-market, low-tax eldorado, personal beneficiaries of the get-rich-quick years, with a huge vested interest in their continuation, Hong Kong’s bankers and financial analysts have contributed to the idea that the party would go on for ever. In the face of a relentless flow of unpalatable facts, though, conventional wisdom is breaking down and interesting voices can now be heard. One is Andy Xie, the chief economist for Greater China at Morgan Stanley.

His secretary met me at reception and escorted me to the 30th floor of No 3 Exchange Square. On the way, she casually opined apropos of nothing: ‘All these mainland tourists. They have so much money to spend.’ It was one of the most striking remarks I heard during my stay. Usually one only hears disparaging comments about mainlanders – that they are poor, uncivilised, inferior, uncouth. She is not wrong. Mainlanders last year accounted for almost half of all Hong Kong’s tourists, and the typical Chinese tourist spends more than any other, including Americans.

Xie is one of a new breed of financial analysts. He is a mainlander, brought up and educated in Shanghai, where his parents still live, before going to graduate school in the US. Dry, dismissive, self-confident, casually dressed, his fluent English flavoured with a strong Shanghai accent, he sings from a very different hymn sheet from conventional wisdom. ‘Hong Kong is in the sh**. Originally when it established its factories in Guangdong, it was not competing with southern China, but now more and more it is, especially with Shenzhen, and especially in retail, property and in port facilities. Hong Kong is a historical accident. It should settle for stagnation and the quiet life, enjoy its wealth. But that is not an option for the poorer people here. They should move to Shenzhen, where it is much cheaper.’

Xie’s argument is arrestingly straightforward and obvious. Before 1997 it was extremely hard for Hong Kong citizens to travel to China, but now around 200,000 pour over the border every day, mainly to Shenzhen – little more than 20 miles from Hong Kong island – to shop, eat and be entertained at less than half the price back home. Before the handover, it was impossible for Hong Kongers to own property on the mainland, but now a growing number of the 70% who cannot afford a property in Hong Kong are buying holiday and retirement homes in Shenzhen for around a third of the price. One property consultancy predicts that property prices in the New Territories – the part of Hong Kong that borders China – will fall by a further 18% this year. Hong Kong’s lifeblood is draining over the border. Shenzhen, a city of over 4m created little more than 20 years ago on the initiative of China’s former leader, Deng Xiaoping, as a rival to Hong Kong, has turned into the latter’s torment.

‘Hong Kong has to recognise the inevitable,’ continues Xie. ‘The process of equalisation is irresistible. The remaining border restrictions should be lifted. They should make the border much easier, like Europe. Then the less well-off can work in Hong Kong and live over the border, where everything is much cheaper. Instead, though, the government has been trying to convince the poor to buy $HK1m [£85,000] flats here. They can’t afford it. Everything here is about holding up the property price. It’s a comedy.’ So what does he think will become of Hong Kong? ‘It will remain a financial centre, but that does not employ many people. It will probably remain a media centre because of press freedom. And tourism, which employs a lot of people, will continue to be important.’

I made a day trip to Shenzhen by overland rail, as any Hong Konger does. My commuter train was packed with islanders going for a spot of shopping and mainlanders returning home. Erica Chan, a 20-year-old student at Hong Kong’s Chinese university, told me that she went on shopping expeditions to Shenzhen three or four times a year. Catherine Ko, married and in her early thirties, who lives in Shatin in the New Territories, went ‘five or six times a year. I shop for clothes, bags and accessories, and go for a massage’. When the train arrived at the border crossing at Lo Wu, a human tide of people was borne along the platform and swarmed into the huge queues at passport control – and this was on a weekday.

I fell into conversation with Patrick Leung, aged 40, who lives in Kowloon and works as a clerk in a car-repair garage. ‘I go twice a month to Shenzhen. I buy clothes, music CDs, usually fakes, which are one-fifth of the price in Hong Kong, and I go to restaurants, which are half the price. I still buy things in Hong Kong, but I get as much as possible in Shenzhen. Why not? Things are 30-40% cheaper. It makes sense.’
On the Hong Kong side of the border, 10 young women were giving out glossy brochures advertising flats and houses for sale in Shenzhen. Less than 50 yards further on, just over the border, were 20 smartly dressed young women, all trying to persuade Hong Kongers to buy property in Shenzhen. It was as if the border crossing had been turned into a huge open-plan market for estate agents. Emerging from customs, one is almost immediately confronted by a multistorey shopping mall. Everything is designed for the ultra-convenience of the Hong Kong shopper. Until as recently as the mid-1990s, the former colony was seen as a mecca for shopping, but this now seems a distant memory as Hong Kongers abscond en masse at weekends to Shenzhen, and Hong Kong’s retailers struggle to stay afloat.

Apart from shopping, having a massage, visiting a beauty parlour, enjoying a Chinese banquet, being entertained by a prostitute, spending a weekend in their holiday home or fixing their teeth, Hong Kongers also go to the mainland to work. Not long ago, the very idea would have appalled them. Yet last October, 2,000 people packed Hong Kong’s Convention and Exhibition Centre hoping to find a job at the Beijing-Hong Kong Talent Recruitment Fair. It was the fourth such fair in less than a year.

Some, like Karl Wong Hak-kim, who has two degrees and an MBA and is fluent in Mandarin, Cantonese and English, were high-flyers who believe the future lies on the mainland. Others, like Wilken Liu, a manager who had been out of work for nine months, were there out of desperation and saw the mainland as a way out of their predicament. ‘I am willing to accept less than half what I used to earn but I still can’t find a job. There seem to be no jobs around.’ The vice-chancellor of Hong Kong’s City university recently predicted that 8 out of 10 graduates would work on the mainland. Hong Kongers are voting with their feet and going north.

Albert Cheung hosts Hong Kong’s most popular radio chat show, Teacup in a Storm. He is the populist voice of the territory. ‘They don’t want to spend their money because they have no confidence in the future or in the government and Mr Tung [Hong Kong’s chief executive]. They had confidence in the British governor before. When we returned to China, we had very high expectations. Mr Tung has demonstrated that he is incompetent. So people prefer not to spend their money. It’s a crisis of confidence rather than an economic crisis. We should be okay: China is growing at 8% a year and provides us with a huge economic hinterland.

We miss the good old days before 1997. But it’s very contradictory. Politically, the handover was a good thing. Everyone thinks that. We are Chinese. We don’t want the British back, we want the Chinese to run the place. Zhu Rongji [until very recently the Chinese prime minister] is more popular than anyone from Hong Kong. The Chinese government should send someone over, preferably Zhu, to run Hong Kong. Hong Kong has lost faith in one country, two systems, so at some point the Chinese government will be forced to do something – to send someone over to keep an eye on Mr Tung.’

There has been an extraordinary U-turn in attitudes towards the mainland. For decades, Hong Kongers viewed their neighbours to the north with barely concealed contempt. When there was an outbreak of chicken flu in 1998 and all the territory’s chickens had to be slaughtered, the outbreak was blamed on the mainland (even though it almost certainly started in Hong Kong). Zhu Rongji and Jiang Zemin (until last week president of China) have enjoyed popularity ratings far in excess of any Hong Kong leader. When Zhu came to Hong Kong last autumn, he said if necessary the mainland would use its huge reserves to bail out Hong Kong. Once the impoverished, uncivilised neighbour, China is now seen as Hong Kong’s saviour. Meanwhile, Tung Chee-hwa’s popularity is at an all-time low.

But it is too easy to blame the Hong Kong government. It cannot be held responsible for the effects of historic changes. Sure, it failed to anticipate the crisis and is still trying to come to terms with that. There is no question that it has performed poorly, displaying a lack of insight, consistency and experience. This too is not surprising. Hong Kong suffers from a gargantuan political deficit. The colonial era bequeathed an extremely able group of administrators to the civil service and no political elite – the political decisions had either been taken by the British governor or in London.

Christine Loh, a former member of the Legislative Council who now runs a think-tank and who – reflective, incisive and independent-minded – cuts a highly unusual figure in Hong Kong, argues: ‘Hong Kong doesn’t know how to govern itself. It has no experience. There are lots of bureaucrats who are used to plugging into a colonial model, but now there is no mainframe to plug into. Political leaders like Tung have been catapulted into their positions and are learning on the job – which is making it hard for them and for us.’

This political weakness leaves Hong Kong exposed not only domestically but also in its relations with Beijing. Around the time of the handover, it was fashionable to suggest that Hong Kong was, in effect, the future of the mainland: the last governor himself implied as much. In retrospect, this speculation seems a little absurd. Not only did it underestimate the manifold sources of China’s extraordinary transformation but also the sophistication of Chinese politics and the power enjoyed by cities like Beijing and Shanghai. Alongside them, with their centuries of experience of wheeling and dealing at the Chinese court, Hong Kong is a geographically distant outsider, utterly unversed in the ways of the Middle Kingdom. As its crisis deepens, as it is drawn into growing competition with Shanghai, Guangzhou and Shenzhen, it is that bit more vulnerable, even though the mainland government is anxious, for foreign-policy reasons, to ensure Hong Kong prospers.

Like everyone else, the Hong Kong government failed to read the economic runes after the handover. It was preoccupied with making the ‘one country, two systems’ formula work, which meant preserving as much of the status quo as possible, keeping the mainland at arm’s length and reassuring the West. As a consequence, it failed to grasp the likely effects of growing integration with China and the fact that Hong Kong’s prosperity was unsustainable in its present form.

In particular, it paid little attention to its relations with the neighbouring Pearl River Delta region, above all Guangzhou and Shenzhen, viewing the mainland with the disdain and aloofness that have been characteristic of Hong Kong’s history. Allan Lee, former chairman of the Liberal party, is blunt: ‘The first five years were wasted. Governors and mayors over the border were getting frustrated.’ James Tien, the present chairman of the Liberal party and now a member of the government, is a little more restrained but equally candid: ‘Over the last five years we have been so anxious to observe “one country, two systems” that we resisted economic integration.’

This is beginning to change as the government has come to recognise the nature of the crisis it faces. Donald Tsang, the bow-tie-wearing chief secretary, is Hong Kong’s second most senior politician. Previously, in his role as financial secretary, he was the debonair face of the island’s prosperity. He stresses: ‘We are concentrating on our relationship with the Pearl River Delta. This business model is taking shape.’ The problem is that, in the meantime, ground has been lost, as the Pearl River Delta has been busy integrating on its own, to the exclusion of Hong Kong. James Tien is frank about the situation: ‘We had better not be arrogant, not say we are the leader. Five years ago that would have worked; now it won’t. The fact is they can now undertake a successful integration without us. We are equals.’

But the government is still caught between the old order and the new. On the one hand, it is trying to make up for lost time by integrating with the Pearl River Delta; on the other hand, pulled by history and powerful vested interests, it is trying to shore up the status quo, mainly by bolstering Hong Kong’s traditional source of tycoon and middle-class wealth: the property market. Another example is the resistance to a 24-hour open border. Until very recently, all the main crossings were closed between midnight and 6.30am, in an attempt to discourage the downward economic pressures from the mainland. Now, for the first time, one crossing will stay open round the clock. As Ronald Arculli, chairman of the Jockey Club, a huge organisation that has grown rich on the Chinese penchant for gambling, puts it, ‘By keeping the border closed, the process of adjustment and adaptation has been too slow. The border should be opened up. It’s an artificial attempt to keep the value of Hong Kong up.’

Although Hong Kong has earned a reputation as a doyen of the free market, it is in fact highly cartelised and in many areas anti-competitive, a legacy of the colonial era and the monopoly privileges enjoyed by the old British firms. The consequence is that, in many areas, most notably property, the former colony is artificially expensive, with salaries often very high by European standards. ‘Professionals have bloated salaries and bloated lifestyles,’ says Arculli. ‘They have continuing unrealistic expectations, and Hong Kong can no longer afford them.’

The urgency of the situation is manifest in the growing budget deficit. Hong Kong has always been renowned for its huge budget surpluses and Himalayan-sized reserves, but since 1999 the surplus has turned into a growing annual deficit: the fiscal reserves have fallen from HK$434 billion to around HK$303 billion. At this rate, Hong Kong will have emptied its public coffers within five years if no remedial action is taken.
The most obvious reason for the deficit is the collapse in property values. Although Hong Kong has always boasted very low income tax – for the few that pay, the top rate has been only 15% – this has only been possible because of the large income obtained from land sales and property tax, which together still account for around 25% of government revenue. The collapse of the property market means that this arrangement is no longer sustainable, so Hong Kong is engaged in an agonised debate over how to increase existing taxes and what new ones to impose, while reducing public expenditure, in particular the number and remuneration of civil servants.

The sooner the government tackles these issues, the better. But that is easier said than done. The measures required will increase Hong Kong’s pain. Any government would be sorely tempted to postpone the evil day. Steven Xu, the chief economist for Asia at SG Securities, believes the most likely scenario will be procrastination. There will be ‘continued slippage on the deficit and Hong Kong will become an economic burden on China. We will see increasing intolerance towards new immigrants from the mainland, continued emigration and social unrest’.

In fact, in its recent budget, the government announced a cut of 11% in the income of the quarter of a million domestic helpers, overwhelmingly from the Philippines and Indonesia, who are among the poorest of the population. This measure will make little difference to the budget deficit, but it underlines Hong Kong’s meanness towards the poor, especially if they are of a different race. Hong Kong needs a whole new mindset; it must downgrade its sense of what it is and what it can be. The idea that it is the future of China is, for sure, an absurd pipe dream. More pertinently, it seems unlikely that, in the medium term, it can resist the challenge of Shanghai to its status as China’s foremost financial centre.Certainly when the Chinese currency becomes convertible, then nothing seems likely to prevent Shanghai assuming Hong Kong’s mantle.

As a vivid illustration of rapidly changing fortunes, if one extrapolates from present trends into the near future, then Shanghai’s GDP per head is likely to surpass that of Hong Kong in six to eight years. Arculli suggests that ‘Hong Kong should be the financial centre of Guangdong province.’ This is a realistic aim, but a huge diminution of ambition from the days when Hong Kong saw itself as the fourth great global financial centre after New York, London and Tokyo. But even Hong Kong’s role as the economic centre of Guangdong remains far from guaranteed. Already Shenzhen’s port is carrying a quarter of Hong Kong’s cargo volume, compared with only 4% just five years ago, and it is now established as one of China’s main high-tech centres, a role that Hong Kong itself covets.

Yet it would be wrong to ignore Hong Kong’s strengths. As Donald Tsang, the chief secretary, pointed out, Hong Kong possesses a magnificent infrastructure, the rule of law, open access, a high level of personal freedom, a convertible currency and a very efficient government machine. The problem is that it was assumed that all this would, subject to mainland restraint, deliver Hong Kong a rosy future, and it patently has not. If Hong Kong shies away from full-scale integration, it will find itself progressively marginalised, thereby cut off from its lifeblood. On the other hand, if it goes for full-scale integration, as it surely must, the pain, in terms of a severe reduction in living standards, will be huge. Hong Kong may have got lucky; now it is set to pay a daunting price for that luck.