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China's Entry into the WTO and the Impact on Hong Kong Business

Executive Summary

Background
After 13 years of negotiations, China and the United States signed an agreement on November 15, 1999, paving the way for China's entry into the World Trade Organization (WTO). On May 19, 2000, China completed negotiations with the European Union (EU).   Admission procedures in Geneva will soom begin after China finishes negotiations with a handful of remaining countries.  Therefore, China's accession to the WTO should be a reality by the end of 2000.  This will be an important milestone in the economic development of China.

Firstly, the reduction in tariff and the liberalization of trading rights will boost trade for the Mainland as well as demand for trade-related services. The commitments offered by other WTO members will give China a better chance to promote its products and expand its international market.

Secondly, WTO entry will put China back in the international investment spotlight. Investor confidence had been low recently due to perennial losses by multinationals and a series of defaults. Market access restrictions in various sectors will be relaxed. Rules and regulations will become more transparent and more consistent with international practice. Investors will appreciate the establishment of a more open and equitable investment environment.

Thirdly, although foreign competition will bring some short-term turbulence to China's domestic industries, it will accelerate the quality awareness of Chinese enterprises and put pressure on them to improve their productivity and efficiency. Those who can survive can be global competitors.

Fourthly, China's entry will mean its commitment to a systematic and formalized plan with concrete steps for the opening up of its domestic service industries. Liberalization in the telecommunications, financial services and distribution sectors are all key to speeding up the development of the entire economy.

Lastly, with WTO membership and the impending approval of China's Normal Trading Relations (NTR) status by the United   Status Confress, a foundation for the long-term steady development of Sino-US trade and economic cooperation -- which should have a stabilizing effect on a volatile bilateral relationship. Furthermore, after the accession, all future trade disputes can be resolved by the WTO multilateral dispute settlement body rather than through bilateral negotiations.

From May 1999 until January 2000, nine working groups of Chamber members analyzed the effect of China's entry into the WTO on their business sectors and came up with the following findings:

Opportunities for Hong Kong
There is no doubt that the reduction in tariff, the liberalization of service industries, and the increasing transparency and rule-based commerce brought about by China's WTO accession, along with a general rise in Chinese living standard due to the anticipated economic growth, will benefit Hong Kong.

Market Expansion
There will be market expansion opportunities for many sectors, especially for trade in goods and services. After China's accession to the WTO, the total volume of Hong Kong's entrepot trade and offshore trade will increase and demand for import and export trade related services, such as sourcing, merchandising, and distribution, will also rise in tandem with this growth.

For example, Hong Kong businesses can set up merchandising / sourcing centers in major Mainland cities for the display of Hong Kong products as 'showrooms' for Mainland buyers to enhance their understanding of the kind of products available. With their transportation facilities and marketing skills, Hong Kong businesses can also re-package and export Mainland products to the international market. The elimination of textile quotas in 2005 will rebuild the Mainland position as a viable textile production base and in fact attract more foreign garment manufacturers to channel their investment back into China through Hong Kong. Fashion manufacturers can also develop their own brand products or capitalize on their relationship with the brand proprietors to obtain the license to produce and sell in the Mainland.

Hong Kong financing of imports, exports, and re-exports will grow along with the trade growth. One source of such demand will be Hong Kong's manufacturing base in the Mainland as orders are sure to be boosted with permanent NTR status. Increased lending to Hong Kong companies who will remain as principals in sales contracts - even for trade of goods shipped directly to/from China - should also occur. Hong Kong's role as "deal maker" - e.g. financing, legal, accounting services provision - will expand.

Market Access
The liberalization of market access will benefit services sectors, including legal, accounting, banking, insurance, trading, retail and distribution, and telecommunications, which are now heavily regulated in the Mainland.

The opening of banking business to foreign investors will give Hong Kong banks the opportunities to upgrade or set up new offices in the Mainland to serve an increasing number of clients. Partnerships with Mainland banks could be a possibility. Market access for foreign insurance firms offers opportunities not only for individual life insurance, but sophisticated health insurance products as well as other general and reinsurance businesses.

The elimination of restrictions on trading and distribution rights will mean better opportunities for Hong Kong's transport and logistics companies to expand their business into the Mainland market. A successful logistics center will not only improve the domestic distribution network but also facilitate the import of products and thus be of great aid to the domestic retail business. In fact, the more open retail market could also be lucrative for Hong Kong retailers, especially since the eventual rise of living standard in China will greatly increase the purchasing power of the average Chinese.

The opening of the telecommunications market presents Hong Kong companies, which provide advanced fixed network, paging and mobile services in the region with opportunities in gaining market share in these segments. Much of the Internet fever in Hong Kong is predicated on the opening up of the Mainland Internet market.

Legal, accounting, marketing, public relations/advertising and other service sectors will open up in China, facilitating the setting up of offices in the Mainland by Hong Kong firms.

Middleman's New Role
For many sectors, such as insurance, retail and distribution, trading, Hong Kong has been for a long time a jumping-off point. Multinationals currently in Hong Kong are unlikely to move their regional head offices to China where the "soft" infrastructure and skills are not readily available. Hong Kong's legal system and international character will continue to be a major asset for some time to come. New players, especially SMEs from abroad, can find know-how and expertise in Hong Kong to help them do business in the China market that will continue to be very diverse and complex.

Likewise, after China's accession into the WTO, Mainland enterprises will have to face more severe competition from foreign competitors. Mainland enterprises will also have better opportunities to expand into the global market. In both circumstances, they can seek assistance from Hong Kong to adopt international business practices. With the relaxation of restrictions on professional services, including foreign law firms, accountants, management consultants, architects, engineers, urban planners, etc, Hong Kong professional firms can expand their business in China. Mainland enterprises will become their potential customers.

Furthermore, investment banks in Hong Kong can help Mainland businesses raise funds in the international market. Hong Kong investment firms can help facilitate the Mainland's ability to mobilize capital, thus encouraging stock market participation and stimulating related financial service activities. The Growth Enterprises Market (GEM) has aroused great interest in China already, and listings on GEM and the Hong Kong Stock Exchange will grow. When the Chamber -- in cooperation with the China Enterprise Confederation in Beijing -- organized two week-long workshops on "Attracting Foreign Funds in China's SOE Reform" in 1999, almost 200 senior executives from Mainland state-owned-enterprises explored in depth with Hong Kong professionals on how best to obtain international funding.

Challenges for Hong Kong
Despite all the opportunities, a more open China market will not automatically benefit Hong Kong. Hong Kong businesses need to overcome the challenges that lie ahead.

Barriers and Constraints
Notwithstanding the relaxation in market access in China, many sectors are still subject to a high level of entry requirements and operational restrictions. In addition, the licensing or the approval processes, for example in banking, insurance, retail and distribution sector, are likely to continue to be slow and painstaking, with cumbersome application procedures and formalities.

For example, foreign banks must currently fulfill the asset requirement of US$20 billion and various other funding requirements for setting up a branch in China. To set up a joint venture commercial retail business in China, foreign enterprises need to have an annual turnover of more than US$2 billion and assets of no less than US$200 million. The asset requirement for joint venture wholesale business is as high as US$300 million.

Market inefficiency is another concern affecting operational effectiveness in the Mainland. In the insurance market, foreign players have to face difficulties like the lack of qualified agents, backward management, and incomplete supplementary rules to the Insurance Law. The development potential of e-commerce is hindered by the low ratio of personal computers to households and the inability of China's banking system to support Internet-based online transactions.

The lack of regulatory transparency and predictability, especially of implementation procedures, also creates great uncertainty and strains in doing business in the Mainland. To some extent the operational difficulties have been circumvented by arrangements with local provincial authorities, where Hong Kong businesses tend to overcome such barriers on a case-by-case basis. WTO entry will, however, signal the Mainland's move to a more rule-based system, so the old way of relying on flexibility and on things to "work themselves out" will not be good enough in the new environment.

The intention of Chinese authorities on how the market should develop and their position on the market economy will also affect foreign investors. Investment firms cannot penetrate and mobilize China's capital market if the desire for Chinese enterprises to seek foreign capital is not made easy by the procedures for foreign listing. As a result, the role that the GEM and stock markets around the world can play as fund raising outlets for Mainland enterprises will be lessened. In many disciplines, the Mainland administration has yet to divorce itself fully from enterprises and services providers. This dual role makes it difficult for Hong Kong professional firms to compete on an equal footing and to penetrate the market.

Finally, it is well known that there is resistance in some sectors within China to some of these WTO commitments. Also, implementation of the complex commitments will not be smooth. One should realize that WTO commitments by the Chinese government do not need to translate into decisions by individual Chinese companies, and interpretation of the commitments will most likely vary from location to location and from official to official.

Increased Competition
Market liberalization will bring in more outside players, and thus increase competition, not only from multinationals but also from the Mainland's own developing indigenous business sector.

From Multinationals
With a stronger capital base and often more political clout, and being more "well-connected", the bigger multinationals are more capable in overcoming entry barriers and enjoy better bargaining power in negotiations over terms and conditions in setting up new operations in the Mainland. Furthermore, the Chinese government has thus far shown an inclination to encourage multinationals, rather than smaller companies based in Hong Kong, to participate in its liberalized program such as experimental projects.

From the Mainland
Hong Kong companies are inherently less familiar with the characteristics of the local market when compared to indigenous Mainland enterprises. In time, with the improvement of the management skills of Mainland enterprises, Hong Kong companies who lack sophisticated expertise on the Mainland will lose their competitive edge.

For example, in the retail and distribution sector, placing a Hong Kong management team in the Mainland is expensive, but simple management systems such as EPS, bar codes, etc could be picked up easily by Mainland firms. In the technology sector, some Mainland manufacturers are already securing needed technology by teaming up with foreign partners, opening offshore design centers, and hiring engineers from multinational companies. For these Mainland technology companies, their competitive edge lies not only in low production costs and standardized production skills, but also in a large pool of technical personnel and in the capability of producing high-end products. The level of expertise of the Mainland's garment manufacturers has also improved significantly. They are becoming increasingly capable of producing high quality garments. In fact, a number of Chinese indigenous garment brands have flourished over the past few years.

Diminishing Gateway Function
With a more transparent trade regime in the Mainland, Hong Kong's gateway function will diminish gradually as more foreign companies may try to go to China directly, and as China itself catches up through, among other things, advancement in telecommunications and information technology. Hong Kong trading firms that match sellers and buyers without adding any significant value to the process -- the "left-hand-right-hand" traders -- will be faced with a trend toward more direct dealing between customers and manufacturers in the future.

There are also increasingly sophisticated trade-support functions within China, e.g. the ports and "higher-value" functions like merchandising. The choice between direct shipments and transshipments depends largely on the availability of cost-effective and reliable transport services. Port charges in Hong Kong are expensive and Chinese ports will become a competitive threat as they have cost advantage over that of Hong Kong ports. As the pace of liberalization continues to accelerate in China, the advantage of ease of transshipments and customs procedures in Hong Kong will diminish.

Mainland's Relationship with Hong Kong
Hong Kong is constrained by the fact that being part of China, it cannot realistically engage the Mainland in bilateral negotiations. The Hong Kong SAR government has been hesitant to date to be more pro-active in arguing the case for Hong Kong businesses in the Mainland. The Mainland's view of Hong Kong, whether as an investor, a middleman for funding, or as a springboard for foreigners, is crucial as it will affect the positioning of Hong Kong.

Hong Kong's Competitiveness
Besides external factors, Hong Kong businesses are facing internal challenges and weaknesses as well.

A major factor that can erode Hong Kong's competitiveness is our high operating cost. High salaries and property prices are the two biggest cost items for many Hong Kong businesses -- the textiles sector being an obvious example. Costs for professional services are also high.

In addition, there are concerns over the inherent weakness of Hong Kong's education system. Many businessmen share the sentiment that the education system in Hong Kong has not produced sufficient people that are suitable for the new economy. They fear that many graduates do not possess the proper technology and language skills -- in English and Putonghua -- that are needed in shaping Hong Kong as a value-added provider and international linkage.

What Hong Kong Businesses Can Do
Whether Hong Kong can remain competitive and take advantage of the liberalization in the Mainland will depend on how Hong Kong positions itself. Hong Kong businesses should rethink their role, and this will call for restructuring, diversification and upgrading. Although Hong Kong is now part of China, it is extremely important for the business community to maintain its international character. We must play up our role as the "Value-added, Two-way Bridge" to and from China.

Value-added
Trading companies should focus on value-added trade-related services that meet the changing environment and operating style in China. With expertise in port specialization, logistics and operation, and product customization, Hong Kong can provide an efficient "one-stop" export service to overseas customers that includes sourcing, freight and insurance handling, and quality inspection. They should also utilize information technology such as e-commerce, to facilitate the penetration into the global market.

The textiles and clothing industry should concentrate more on the merchandizing and designing functions and develop Hong Kong as a leading fashion design and merchandizing center. They should seek ways to improve productivity, which includes automation in the manufacturing process and the use of information technology in shortening manufacturing and order lead-time. OEM manufacturers with design concept and brand development techniques should develop a 'Made in Hong Kong' branding.

Insurance companies should offer modern, high-value specialized insurance services. Securities houses should develop niche areas like on-line securities trading.

The telecommunications sector should explore business in a wide range of value added services, such as mobile network, wireless data and Internet services, especially of the business-to-business variety.

Technology companies should explore unique development areas, such as localization and "bilingualization" of international IT products, and build up recognizable high-tech brand names, Internet applications, and e-commerce.

Two-way Bridge
Hong Kong businesses should consider establishing strategic alliances with multinationals as well as with Mainland enterprises.

With Multinational Companies
Teaming up with multinationals can increase the capital and technical support of Hong Kong enterprises and thus secure a stronger position in the Mainland market. The scope of cooperation is wide, including such areas as joint ventures for professional and financial services, market development in the Mainland, transfer of technology, production management, marketing and training. Using the telecommunications sector as an example, through partnerships with foreign companies that have a strong technical support base, Hong Kong can provide technical assistance in digital cellular infrastructure, broadband and high-speed fiber transmission, which is sought by Mainland companies.

In addition, Hong Kong should strengthen its role as a headquarter city servicing the Mainland business expansion of multinationals by sustaining its international character, keeping its high standard of services, maintaining the rule of law, providing a pleasant environment, and lowering the business operating costs. Multinationals expanding in Hong Kong by investing here and by hiring Hong Kong residents -- provided they can bring expertise and language skills to the job -- is also good for the Hong Kong economy.

With Mainland Businesses
Hong Kong's considerable experience in services exports will make it an ideal party to improve our Mainland counterparts' competitiveness and quality of services, at the same time, to strengthen its knowledge of, and connectivity with, the Mainland. For example, distribution can be done in the Mainland while Hong Kong acts as a control center. Hong Kong companies have a lot of experience in retail and distribution concepts, advertising, and brand packaging experts. Hong Kong companies can join forces with Mainland enterprises to increase their domestic retail power and to create labels/brands of their own and have them exported overseas.

Leveraging on China's R&D capability, entrepreneurial Hong Kong firms can provide their market knowledge and expertise to modify and commercialize China's research results into business opportunities. Hong Kong companies can also team up with universities in the Mainland to leverage on China's technology research and development.

Hong Kong should also look to cultivating Mainland clients, especially SOE's, who must fight against more formidable foreign competition within China. They would need Hong Kong's management consulting, legal, taxation, accounting and public relations skills. These Hong Kong firms can go it alone or can team up with Mainland firms in these areas. Likewise, Mainland enterprises may also hire Hong Kong professionals to work in the Mainland.

Among Hong Kong Companies
An alternative for smaller businesses in Hong Kong is to consolidate into fewer bigger and stronger alliances to take advantage of economy of scale to improve competitiveness. The alliance need not be through outright acquisition. There are different forms of cooperative initiatives. Besides, connected businesses or organizations can come together as a group to promote themselves. Joint promotional programs including seminars, exhibitions and workshops can be organized. In this connection, the Hong Kong General Chamber of Commerce can play an important role to promote the interest of Hong Kong businesses.

Knowledge Base
An important aspect is that Hong Kong businesses badly need greater understanding of Mainland rules and regulations. Businesses also need to polish their language skills -- both English and Putonghua. To advance Hong Kong's technology standards, Hong Kong manufacturers should increase their involvement in research in production engineering, engineering design or development of components for functional efficiency.

Hong Kong's advantage in management and other service sector skills must continually be improved to match or stay ahead of international standards. Otherwise, Mainland's capability in these areas can in time catch up with us.

What the Hong Kong SAR Government Can Do
There are several ways that the Hong Kong SAR government can assist Hong Kong businesses.

Dialogue Between the SAR and the Mainland Governments
A SAR government-to-Central government communication on liberalization and deregulation will no doubt be of great help, especially in areas such as fair and reasonable criteria in awarding licenses to operate in China, or a more transparent investment policy and tax and tariff regime, or rules implementation uniformity. The government should also convey to the Mainland government the importance of eliminating regulatory ambiguities, and uncertainties or barriers that keep out Hong Kong companies. The recently established Mainland / HKSAR Joint Commission on Commerce and Trade is a good start in promoting a regular dialogue between the governments.

In the opening of the Mainland market, Hong Kong's interest lies in ensuring a level playing field so that Hong Kong companies are treated equally with others. In view of the active lobbying by foreign governments from Europe, the US and Singapore, the SAR government should consider a pro-active role in ensuring that Hong Kong gets a fair share of the market. The possibility of considering Hong Kong companies for pilot schemes during the phase-in period before the sector is fully open should be explored with the Mainland authorities.

One possible way of achieving this is to explore the benefits of a Free Trade Area agreement with the Mainland, similar to the NAFTA type regional trade agreement, which would be in keeping with WTO rules. Sectors such as banking, retail, distribution and textiles will be able to take advantage of the integration between the two economies for the benefit of both.

In short, while there is agreement that outright preferential treatment for Hong Kong businesses as Mainland companies is unwise, there is a strong belief that the Mainland should be made aware of the desires of, and problems facing, Hong Kong companies. This can be done through channels such as Chambers of Commerce, but most effectively by the SAR government to the Beijing government. In our experience, the Central government cares a great deal about Hong Kong's economic development and would be quite receptive.

Improving Hong Kong's Business Environment
There are also some domestic concerns that the Hong Kong SAR government should address to improve the business environment in Hong Kong.

Operating Costs
High operating cost (in property and wages) is seen as a major negative factor affecting business in Hong Kong. Many businessmen, whether they are traders, manufacturers or service providers, see these costs as very worrisome and are of the opinion that the government needs to lead the way in reducing costs in Hong Kong. Further raising government efficiency and cutting government operating costs would be a good start. Some form of soft loans and export credits operated by the government would also provide very helpful assistance, especially for smaller firms.

Technology Talent
In order to stay ahead, Hong Kong not only needs to exploit its advantages in such things as capital and management skills, but also to develop its innovative ability and to add value. China has a huge pool of electrical engineers and computer scientists whereas Hong Kong lacks skilled workers in the technology field. The Hong Kong SAR Government should adopt liberal policies to attract and, in the long-term, retain a pool of high-tech personnel from the Mainland -- and also from around the world.

Language
Hong Kong, as the region's financial and business hub, needs to improve upon its language education, in particular English and Putonghua. The SAR government can provide subsidies, either in the form of grants or subsidized classes to those wishing to improve their language skill.

Education and Training
The quality of management people in Hong Kong in general is seen to have deteriorated. The government needs to increase spending on tertiary education. Technical education to nurture future technology contributors must be improved, to ensure that indigenous talents will begin to complement imported talents in high technology sectors in the near future.

Trade Facilitation and Promotion
The Hong Kong SAR Government should more aggressively promote Hong Kong's image to the Mainland and overseas countries -- our quality services, our strengths in management and marketing strategy, our international character, our experience in China trade, our proximity to the Mainland market, and our emphasis on intellectual property rights protection.

One useful step would be to set up more Hong Kong trade offices in the Mainland to provide proper channels for communication and liaison with Mainland officials. There should also be an overall promotional plan to market Hong Kong both in the Mainland and overseas, to be mounted by the trade offices or other semi-government bodies such as Hong Kong Trade Development Council or private business organizations such as the Hong Kong General Chamber of Commerce.

The government should also facilitate the formation of an independent non-governmental organization -- composed of major Chambers of Commerce -- to handle trade inquiries or disputes encountered by Hong Kong businesses in China.

Conclusion
This Sino-US accord is a significant step in the process of China's entry into the WTO. China's WTO membership will be a landmark development affecting the business environment in China as well as in Hong Kong. The Chamber working groups believe that, with enough preparation and hard work, Hong Kong businesses can definitely grasp the opportunities. Many of the commitments have a phased time schedule. Hong Kong businesses need to use the time wisely.

A list of China's commitments to the United States was compiled according to informationa provided by the US Trade Representative.   The discussions and the suggestions on this paper are made based on these commitments. The final  WTO commitments by China should resemble largely the ones made to the US, although the EU was able to obtain some additional commitments from China.

The Chamber hopes this report provides valuable insights and stimulates the Hong Kong business community to look positively to the future. It should be added that this report looks at the initial challenges, and businesses will have to constantly adjust to a dynamic Chinese economy that will provide vast opportunities and challenges when China gets into the WTO.