• The manufacturing and trading sector is the largest contributor to the Hong Kong economy. Its direct contribution, according to official statistics, was HK$312 billion (or 25% of GDP) in 2004. The sector also directly employed 773,400 people (23% of total employment) in 2005.
  
  
• Since the sector generates substantial demand for inputs from other sectors, e.g., the financial and logistics services, its importance to our economy is even larger if its indirect contribution is taken into account.
  
  
• Using a sophisticated economic model, our academic experts estimate that the total value-added of the manufacturing and trading sector (direct and indirect contributions together) should amount to HK$558 billion in 2004, or 80% higher than the official figure. By the same token, total employment generated by the sector should be 1,350,000 in 2005, or 75% more than direct employment alone.
  
  
• Exports have always contributed significantly to our economic growth and created employment. Based on our experts' estimation, every 5% increase in exports of goods would boost Hong Kong's real GDP growth by 2.4 percentage points (of which re-exports would contribute over 80% of that GDP growth), and reduce the unemployment rate by 0.6 percentage point.
  
  
• While there are those, including some experts, who worry that the continual relocation of manufacturing and trade supporting activities outside Hong Kong would mean a decline in contribution and employment of the sector, we have a totally different picture. According to the TDC's latest survey, one-third of surveyed exporters did not plan to change their activities in the next three years, while another 45% would expand their activities in Hong Kong, creating a total of 90,000 new jobs.

TDC's Research Department has commissioned Professors Sung Yun Wing and Chou Win Lin of the Department of Economics, the Chinese University of Hong Kong, in using input-output table and econometric models to estimate the indirect contribution and multiplier effect of Hong Kong's external trade.

Executive Summary

The wealth of Hong Kong stands on a firm foundation of industry and trade. But today, only trade remains a growing business, while much of the territory's manufacturing has relocated out of Hong Kong in search of lower-cost land and labour. Statistics also report that Hong Kong's industrial heyday is over. By 2004, only 3.5% of Hong Kong's GDP came from the manufacturing sector, compared to almost 23% in 1980.

To conclude that industry is of little relevance to the Hong Kong economy is, however, mistaken. Industrialists remain active in Hong Kong, operating their local offices as trading companies and business headquarters that support offshore production. The relocation of Hong Kong's industry should thus be more appropriately viewed as an expansion of Hong Kong's industrial sector and as an element which has been helpful in upgrading its services content. Thanks to the relocation and expansion of the manufacturing activities across the boundary, Hong Kong's total trade has increased 22-fold over the past 26 years (1980-2005).

Hong Kong's manufacturing and trading sector is always among the first to recover from downturns. In only three of the past 26 years (1980-2005) were there decreases in merchandise exports. Over the same period, except in 1982, 1999 and 2001, merchandise exports have performed consistently better than GDP. More recent data showed that from 2000-2005, the manufacturing and trading sector outperformed others as the most important contributor to Hong Kong's real GDP growth, accounting for more than 40% of the increase.

Hong Kong's manufacturing and trading sector is not only the main propeller of the domestic economy, but also the biggest pillar among all business sectors, directly accounting for 25% of GDP in 2004. Yet this does not include the indirect impact generated through intermediate consumption. According to our estimates, the total value-added of industry and trade was HK$558 billion in 2004, compared to the direct value-added of HK$312 billion shown by government statistics. As for employment, jobs created by industry and trade totalled 1,350,000 in 2005, versus the official figure of 773,400.

These impacts are not one-off - the income generated by the sector induces consumption spending and creates further demand. Again, according to our estimates, a 5% increase in exports of goods would boost real GDP growth by 2.4 percentage points (of which re-exports would contribute over 80% of that GDP growth) and drag down the unemployment rate by 0.6 percentage point, with reference to data in 2004.

There are those, including some experts, who worry that Hong Kong's trading sector will eventually wane because trade supporting activities would go offshore with the manufacturing industry. Our survey drew a different conclusion - 45% of responding exporters said they would expand the functional activities of their Hong Kong office in the coming three years, while 33% said they would maintain their Hong Kong activities at the present level.

Concerning job creation, our survey shows that 46% of respondents planned to increase their staff numbers in the next three years, creating around 90,000 new jobs by the end of 2008.

Hong Kong companies are facing challenges though. Increasingly, they are encountering exorbitant production costs in the Pearl River Delta region. In response, they might consider moving production to interior regions, moving further up the value chain or branching out into new products. On the demand side, competition is stiff, especially in developed economies. Hong Kong exporters should thus further expand their direct presence in overseas markets to help promote their products and expand their sales channels. Last but not least, they should diversify into emerging markets, particularly the lucrative mainland market.


I. Introduction

The wealth of Hong Kong stands on a firm foundation of industry and trade. But today, only trade remains a growing business, while much of the territory's manufacturing has relocated out of Hong Kong in search of lower-cost land and labour. It seems that Hong Kong has entered a "post-industrial" stage in which services prosper and prevail over industry. Statistics also report that Hong Kong's industrial heyday is over. In 1980, manufacturing represented almost 23% of Hong Kong's gross domestic product (GDP), but 25 years later, its share dropped to merely 3.5%. In contrast, the services sector had a 68% share in 1980, which climbed to 90% by 2004.

To conclude that industry is of little relevance to the Hong Kong economy is mistaken. No doubt production within Hong Kong has fallen, as Hong Kong industrialists opt to relocate production to low-cost places. Manufacturers, however, remain active in Hong Kong, operating their Hong Kong offices as trading companies and the headquarters of their businesses, which are classified as services providers for statistical purposes. They mastermind and control the entire production process from their headquarters in Hong Kong. Such an arrangement not only allows Hong Kong companies to make the most of location advantages and division of labour, but their business activities have also stimulated a huge demand for intermediate services.

The relocation of Hong Kong's industry, therefore, should be more appropriately viewed as an expansion of Hong Kong's industrial sector and as an element which has been helpful in upgrading its services content. Thanks to the relocation and expansion of manufacturing activities across the boundary, Hong Kong's total trade has increased 22-fold over the past 26 years (1980-2005). The earnings from industry and trade have fed into the domestic economy, and propelled the growth of the services sector.

II. Key Development Trends of Hong Kong's Manufacturing and Trading Sector

In the 1980s, as production costs continued to escalate and the labour market became tight, the export competitiveness of Hong Kong's industry weakened. At that time, the opening of China provided a ready solution. Hong Kong industrialists soon expanded their plants across the boundary to Shenzhen and beyond. By making use of outward processing arrangements and related schemes, raw materials and semi-manufactures were imported into the mainland for processing. Finished products were then re-exported to end-markets through Hong Kong. This business model worked so well that by 1988, Hong Kong's re-exports started to overtake domestic exports.

Illustration 1: Components of Hong Kong's Total Exports in 1980-2005

While the industrial sector of Hong Kong was enlarged with the expansion of offshore production, local factories were closing down, going from as many as 50,566 in 1989 to only 15,332 in March 2006. But they were not dead. Some operated (and classified for statistical purposes) as trading companies in Hong Kong, where they managed, coordinated and supported their offshore production activities. Meanwhile, a widening of supply sources at competitive prices also created many business opportunities for traders who had no production activities either onshore or offshore. Many trading firms were set up as a result, with a net intake of 44,810 in number between 1989 and 2006.

Today, many Hong Kong traders still possess this dual operational status. They perform non-manufacturing activities in Hong Kong, providing support services such as marketing, orders processing, materials sourcing, product design and development, quality control, and logistics support to their affiliated factories offshore, particularly in the Chinese mainland. But whether dual capacity or not, Hong Kong exporters are establishing themselves as an integral part of the global supply chain. In contrast to what has been perceived as simply being an intermediary, they have a much wider scope of responsibility than simple matchmaking for buyers and suppliers. They oversee the whole process of value creation, from sourcing or manufacturing to the point products get into the hands of the buyers. This trend of expanding into the front- and back-end of the value chain is exhibited by their shift in business focus from original equipment manufacturing (OEM) to original design manufacturing (ODM) and brand development, which involves support activities beyond what is required for subcontract manufacturing.

Illustration 2: Involvement of Hong Kong Exporters in the Global Supply Chain

Illustration 3: Percent of Hong Kong Exporters Engaged in OEM, ODM and Brand Development

A last point to note is about the changing mode of shipment. First, offshore trade is on the rise. As the seaport infrastructure becomes increasingly sophisticated on the mainland, Hong Kong exporters have established the practice of shipping products directly from their production base to end-markets overseas. This type of trade flourished from the mid-1990s onward, with HK$655 billion worth of goods estimated to be shipped this way in 1994, swelling to HK$1.8 trillion in 2004, or roughly on a par with Hong Kong's re-export total. While the rise of offshore trade has absorbed some of the seaborne exports from Hong Kong, airborne exports from Hong Kong are fast catching up and now represent 30% of Hong Kong exports in dollar value terms, up from less than 20% before the opening of the new International Airport in 1998. Higher-value merchandise, such as electronics device and parts, is mainly shipped this way.

Illustration 4: Offshore Trade Conducted by Hong Kong Companies from 1988-2004

III. A Closer Look at Traders' Activities in Hong Kong and the Mainland

In all aspects, the relocation of Hong Kong's industry should be viewed as an expansion of Hong Kong's industrial sector and a helpful element in upgrading its overall services content. From a geographical perspective, this nevertheless means the hollowing out of industrial activities away from Hong Kong. There are those, including some experts, who worry that Hong Kong's trade sector would wane because trade supporting activities would also go offshore with manufacturing, a phenomenon that has already happened to logistics arrangements related to ocean transport amid the rise of offshore production and direct shipment.

To check this out, we conducted a questionnaire study between March and June 2006. We surveyed 682 exporters in Hong Kong about their local and mainland trading activities. We found that some trade supporting activities had gone offshore but they were relatively lower value-added, such as manufacturing and transport arrangements. Exporters make Hong Kong their operational and control centre to coordinate and manage their businesses in China and various parts of the world. They carry out higher value-added services inland, while climbing up the global manufacturing value chain. We also found that their activities in Hong Kong and the mainland were strategically placed to exploit comparative advantages and the economic complementarity of different locations.

Illustration 5: Local and Mainland Activities of Hong Kong Exporters

Note: Figures in parenthesis indicate the percent of respondents undertaking the corresponding activities in Hong Kong (chart at the top) or the Chinese mainland (chart above).

Illustration 5 compares the kind of trade-related activities being undertaken in Hong Kong and the mainland, with the figures in parenthesis indicating the percent of respondents performing the specific tasks. We found that Hong Kong plays a crucial role in the strategic coordination and management of widely dispersed operations, whether in Hong Kong or elsewhere. Our survey revealed that 85% of respondents carry out overall management and planning in Hong Kong. Other responsibilities assumed by their Hong Kong office include trade documentation (92%); finance and accounting; sales and marketing (89%); logistics, warehouse, shipping and consolidation (83%); and trade financing and insurance arrangements (82%).

While Hong Kong has a very strong position on the right-hand side of the radar chart, China is exceptionally competitive in the top left quadrant, which represents the most labour-intensive part of the whole manufacturing value chain. We found that 79% of respondents had manufacturing activities in China and some 74% were involved in production management and coordination. There were also 80% of respondents performing quality control in China. Other relatively strong positions in the mainland are the purchase of raw materials (75%) and logistics, warehouse, shipping and consolidation (73%).

Our study confirmed that exporters were keen to place their activities in different locations to their advantage. For activities that are labour-intensive yet requiring little skills, labour costs will largely determine the location. Soft goods production generally falls into this category. As for procurement and transport arrangements, since the underlying activities are standardised, the competition force will also be cost-driven and decided by their proximity to production. There are alternately a number of activities that are knowledge- and information-driven, such as headquarters functions, finance and accounting, sales and marketing, and trade financing. For these activities, traders are more concerned about the business environment, ease of movements of capital and information, infrastructural support, property rights protection, etc.

This explains why Hong Kong is stronger on the right-hand side, while China is in the top left quadrant of the radar chart. The settings are generally complementary to one another, with Hong Kong and the mainland focusing on different activities within an enlarged industrial sector. The settings will however evolve over time. In some areas of activities, for example, Hong Kong and the mainland may now be considered as competing locations. Such areas include procurement of raw materials, transport arrangements, and product design and development, with the difference in the activity level in Hong Kong and the mainland relatively close.

At any rate, our survey revealed that exporters remain keen on expanding their trade supporting activities in Hong Kong. Some 45% of respondents said they would expand the functional activities of their Hong Kong office in the next three years, while another 33% would keep the activity level unchanged. For those who expect an expansion, the main reason quoted was "important role of Hong Kong office as company's headquarters or regional headquarters", with 69% of this sub-group in the affirmative, followed by "business expansion into new industries or markets" (60%), and "need a sales and marketing team of Hong Kong staff" (58%).

However, 22% of respondents would reduce the functional activities of their Hong Kong office in the coming three years due to the off-shoring of some local activities (72% cited this as a cause) and reduced regional responsibility (53%). Other leading reasons for scaling down included "competition or losing competitive edge" (57%), "poor business'' (33%), "sluggish economy / weak business sentiment" (27%) and "outsourcing activities to third-party companies" (25%).

Illustration 6: Reasons for Expanding the Functions of Hong Kong Offices in the Next Three Years

Illustration 7: Reasons for Reducing the Functions of Hong Kong Offices in the Next Three Years

A few areas of activities stood out when we asked respondents about their future plans. In particular, areas that attracted more attention include management and planning, sales and marketing, product design and development, quality control, trade financing / insurance arrangements, and trade documentation. These were the areas in which our respondents would be most keen to expand. Respondents, however, have a fairly diverse view in a few areas like logistics, warehouse, shipping and consolidation. In some cases, the scope of the concerned area may be broad enough for respondents to expand in the higher value-added range. Detailed results can be found in Illustration 8.

Illustration 8: Changes in Local Activities in the Next Three Years

With more activities to take place in Hong Kong, it is expected that exporters will hire more workers in the future. Our survey showed that 46% of respondents would increase their staff numbers in the next three years and 37% would keep the number unchanged, while some 17% would hire fewer workers. Each company would on average hire an additional 0.8 worker over the three years. Bring together the official establishment data for the trade and industry sector, we estimated that about 90,000 new jobs would be created by the end of 2008¹.

We found that there was a strong demand for workers to do management and planning, product design and development, sales and marketing and quality control. The findings are consistent with the results that we mentioned earlier on the kind of local activities that exporters would be eager to expand. One caveat: as most companies have very few workers, staff members usually may be required to take up more than one responsibility.

Illustration 9: Changes in Staff Employment in the Next Three Years