Hong Kong in the New World
The Citigroup and Asia Society Global Issues Series
Kenichi Ohmae
Founder and Managing Director, Ohmae & Associates
Hong Kong, August 29, 2003
Thank you Stephen and Ronnie. It is a great pleasure for me to be able to come to Hong Kong to share with you my time-honored and favored subject of the emergence of the regions against the nation state.
I was given by Ronnie Chan this subject, "Hong Kong in the New World: where to go from here?" Now the pressure on me to give an excellent and new perspective to you is off after this wonderful lunch you have, sort of, monies' worth already so what comes out of my speech is going to an extra dessert, if you like.
I am going to spend some time talking about the shape of the world as we move, and as we have moved into the 21st century. I would say the 21st century economy, the history and origin dates back to 1985; it doesn't have a very long history yet. On everything that has affected us to date and will affect us in the future, at least near future, was originated in 1985 and I call before 1985, "BG" and after 1985, "AG" as in anno domini, and of course what this "G" means you all can guess.
First, in 1985 Gorbachev was elected and he was the incarnation of reform in the then Soviet Union. He didperestroika and glastnosti, made the country quite transparent, open and tried to change everything that had been troubling that country. When he did that the country disappeared. This, all of you know, as a consultant management consultant, if I walk into a company and tell what is wrong with the company and try to fix the problem, you don't have a good company; you just have an ordinary company without problems. Gorbachev didn't understand the end objective of his reform; that is why they have fallen into trouble.
Don't try to fix the problems. Think about the future, what kind of country you want to be and then remove bottlenecks. It is the only way to achieve it. Along with it, if you are lucky and successful, the bad things will disappear. Don't try to fix superficial, bad phenomena and you, as a corporate executive know this very well: you have to have the vision and the concept to get to that vision, along with it the bad things will disappear.
Plaza Accord was very important. Japan had ¥235 to the dollar as an exchange rate. In order to lighten America's burden, debt burden, we agreed to float Japanese yen particularly downward or upward for Japan and dollar downward. We have learned that this kind of currency manipulation hasn't done anything to the Japanese competitiveness. We were able to survive until it was ¥80 to the dollar and strong companies like Fuji Film and Toyota were still able to make money. This has a profound implication on the argument of Renminbi. Even if you were to float RMB, I don't think China will lose competitiveness. Learn from the history, recent history.
Gramm-Radman to remove some of the government superfluous spending was a very, very good idea. Japan hasn't seen the lights of Gramm and Radman and we are still spending more money than our future generations, three generations from now, can ever pay back.
Windows version 1 was introduced on this day and thereafter the whole world had changed. You and I can communicate; you can get my presentation today on Bill Gate's platform. The world has adopted internet and particularly this Window's protocol so that English language has become the dominant language of communication, some 80 per cent of the communication that is exchanged on the internet is now in the English language, and America's dominance has occurred as a result, and that is why 1985 is called "Gates' era" - "Before Gates" and "After Gates".
But all of these important things that have changed the world landscape of social/political world all took place in 1985. Remember in 1985, Time magazine and Newsweek had Japanese companies like Sony with Colombia Pictures acquisition, Statue of Liberty and Mitsubishi Real Estate taking over the Rockerfeller Center and they were saying "21st century is the century of Japan and America's continuing decline". That was 1985. Okay, so you can tell how right these journalists are and when they (decorate) the Time and Newsweek of the world that is the beginning of the decline.
These are the events that have changed the world in a fundamental way, now shaping the 21st century. America's super-dominance originates in this era. China is the single most important country taking advantage of these changes, these forces at work. They have done this either instinctively or purposely, but better than any other nations. Japan, Indonesia and other centrally controlled countries are still suffering because they have not wakened to this new reality of the world. Okay?
Hong Kong, in my opinion, is still in the old paradigm, waiting for the good ole days to come back, and I am sure you have opposition to this view, but let me first state why I say this. We need to understand what is the era AG, after Gates? We are now 18 years after Gates, it has got a relatively short history and what are the characteristics of this era, AG, like?
Most of these things that we observe are invisible; that is why I wrote the book called "The Invisible Continent". Things that influence our economy, our life, are not readily visible. The new economy is fundamentally borderless, cyber and, in financial terms, multiples and derivatives. It is only equation. You cannot touch as you were able to touch coins and notes.
Most critical economic resources or "4 C's" – communication, capital, corporations, customers – freely crisscross the national borders and authorities. That is why it is a very slippery world, and that is why all of a sudden successful countries could be arbitraged out, as we saw in 1997/1998 as in the Asian crisis.
China, on the other hand, has taken advantage of this new paradigm. It is the largest recipient of capital and technology from the rest of the world to date. Before it was the United States, and now China has become number one.
Beijing's influence on regional matters, cities and provinces is decreasing fast and this is one way, once you give authorities to the regions' mayors and governors they are not going to give up these authorities and, of course, after 1985 America's dominance, ie Pax Americana, has expanded to the extent that they can define what they mean by weapons of mass destruction and what do they mean by the declaration of war, etc. And China, interestingly, is taking this American dominance for granted. So long as America is helpful to make China stronger, economically; they may resist ten years from now, but for the time being let the Americans work for them and then I am sure China will have strong enough resources, ten years, 15 years from now, to be able to argue back to the United States.
This is the trend of foreign direct investment. It also suggests the problem of ASEAN. No money is coming into ASEAN and almost all foreign capital is going to China, and this is in comparison with the American – Clinton's euphoric eight years was the peak of getting money from the rest of the world – and, of course, the Greenspan's of this world set the interest rate very high so that they have the magnets to attract capital from the rest of the world.
The new Bush administration doesn't seem to understand this equation and therefore investment into the United States is decreasing sharply and, in its place, China has become the number one location or destination of the global capital.
That China is now driven by foreign affiliated companies, FACs, in both import and export over 50 per cent is controlled or orchestrated and managed by foreign affiliated companies; so it is a rental economy. It is not the Chinese by Chinese; it is many of you from Hong Kong; it is many of us from Japan, Europe and the United States. China is the most hospitable location today for some producers and service providers and that is very important to understand because, if Beijing scares them, they will evaporate and it is a very delicate balance between the psychology of Beijing and the psychology of the foreign affiliated companies.
Hong Kong against this background is at the crossroads. I think many people in Hong Kong today are too pessimistic because people in Hong Kong do not have the right perspective on China, ASEAN and the rest of the world, in my opinion. I have spoken with many of you and I have a feeling that you are pessimistic about the future of Hong Kong.
The rest of the world does not understand the phenomenon called "97". And Beijing also has a wrong model of governance in which Hong Kong is a leading index to other disputed and/or problem regions, such as Taiwan and Tibet. So they say, "We have to do very well with Hong Kong. Hong Kong's success is very important because others will then accept this model". China, itself, today is already moving into a federal or commonwealth model. Therefore it is not like Hong Kong, or Taiwan, or Tibet is integrated into one country centered around Beijing. I call this "The United States of Chunghwa", or "Commonwealth of Chunghwa", and this is completely in line with the successful regions of the world.
If you look at the successful regions they are all receiving money, companies, technologies, information from the rest of the world. Very few countries with natural resources or commodity capabilities are prospering. It is Denmark, it is Finland, it is Ireland, it is Singapore, and now it is regions of China that are attracting resources from all over the world.
Japan is trying to borrow money from the grandchildren and trying to use our own taxpayers' money to turn around. That is the fundamental problem. We should borrow from the rest of the world. We have to open up so that the rest of the world would love to come to Japan, second largest market in the world and the bipolar opposite policy by our central government is the very cause of the problem of Japan, which Japan has not recognized, nor has Indonesia, nor have many other centrally controlled regions.
Today in China authorities are very much delegated to the cities rather than to the provinces. Cities with more than 3 million people compete for the "4C's" – communication, corporation, customers and capital –from the rest of the world. It is the cities' competition, and tough competition among Chinese cities, that are giving them the energy, entrepreneurship and all the dynamism. It is a competition that is in China; it is no longer allocated by Beijing, but it is the competition among the best performing regions in China.
In that sense, China is more like the United States of America or EU in governance, at least economically, and in this context Communist Party in regional government is like a religious organisation – "Communism is good, do you believe?" "Yes, it is good." So long as you say it is good, anything goes underneath it and it is almost like a holding company over an operating unit; it is a corporate model, and this is the United States of Chunghwa – all these coastal regions – and I see maybe 20 Hong Kong's and I also see maybe a dozen Taiwan's along the coast. Sizewise, they are bigger; look at this chart.
On the left side is the population, center is GDP, and on the right is per capita GDP. If you add to the list of these six region states of China, the Chinese, or Chunghwa regions of Singapore, Hong Kong and Taiwan, nine of the top Asian countries, as you will, "countries" are Chinese. Asia is Chunghwa; Asia is China, and that is a very important perspective to develop. It is no longer competing country against country; it is region against region, and this is the overseas Chinese activity in ASEAN.
Basically ASEAN is a city culture. When you talk about Indonesia it is basically Jakarta and Thailand is basically Bangkok, and that is ten per cent of the population. But look at the influence of overseas Chinese: small population except for Malaysia and Singapore, but the market capitalization of these countries is predominantly, I would say, 60 per cent to 80 per cent overseas Chinese and therefore, when I say Asia is Chunghwa, I really mean it except for maybe Japan and Korea.
Japan's stagnation is obvious because we have not created big cities. Cities are the engines in contemporary world economy. In 1990 we had 11 cities of over one million people. In 2000 we had only added two million additional cities by merger of smaller regions.
Look at China: this is 1990, 20 cities of over one million and 2000, 166 cities were over one million, and they are Hong Kong's competitors. Cities with over three million will become Hong Kong's contender right away in terms of competing for capital corporate investment and cluster of talented people, etc. Your competition today is 100 plus. That was not the situation. You created Shenzhen very successfully ten years ago, but how many of these cities can you create or can you compete against when they too are trying to get the resources from all over the world directly – not via Hong Kong – but directly? That is the nature of the challenge.
I will give you an example of north eastern states: Dalian, for example, has about a half million people who are conversant in Japanese language, so I just opened the Japanese contact centers and data entry centers in Japanese language using the internet. The cost is one twentieth, as I show you on the right hand side, and these peoples comprehension of Japanese written language is so good that they are like Japanese operators for business process outsourcing.
There are two million in the north east who are conversant in the Korean language and on the days of internet and voice-over IP they are as if in your backroom, and Japanese companies are trying to move their production plants in China, but that is only 25 per cent of total cost. Seventy per cent is white-collar work and therefore, unless we become competitive in the back rooms and supporting infrastructure, we can never become competitive in the international community. And this is where the new competition is, and this is how we see China today.
That is IQ intensive instead of labor-intensive industries all migrating through the telephone lines and through the internet lines into China. China phase II, which is IQ based contribution to help our companies, your companies, become competitive in the world place.
A lot of people will argue that China should float RMB. From our experience in Japan after Plaza agreement, this is not going to change China's competitiveness in my opinion. Short term it will appreciate significantly, as their trade surplus is huge; maybe two to three fourth, as we have seen between the yen and the dollar. Plaza agreement 235, peak time ¥80 to the dollar. But no country has increased their currency value against the dollar, except for Japan and Germany over the last 40 years. Brazil, Mexico and many other countries have, in fact, decreased their value – even Italy – and therefore you have to be careful about floating in order to reduce China's competitiveness because, eventually, one single mistake, some arbitragers could take advantage of Chinese policy mistakes and the currency could go down. Therefore this is going to increase the instability of China. That is why I am fundamentally skeptical about those who argue for currently floating the Renminbi.
I am also skeptical about the effect of floating Renminbi because Chinese manufacturers, as I know them, will remain competitive, as they are able to do what we were able to do, which is pass the price increase to the market; make better products, smaller, lighter; and reduce cost faster than the currency appreciation, and we survived against the four times appreciation of the yen.
Now, this is not the case when you are exporting commodities, as Australia is exporting commodities, or Argentina is exporting commodities like grain. If you are a commodity based economy it is directly proportional to the currency, but if you are a manufacturing economy there is so much room to improve productivity and competitiveness, and today I have to say Chinese management is capable of combating against strengthening RMB.
Increased purchasing power of China is a huge plus for Hong Kong, leading to, probably, an unhealthy bubble. Hong Kong will experience a bubble when this happens, but it is a golden opportunity for China to improve quality of life and lower the cost of living if they were truly open to the rest of the world. China, at that time, will statistically become G5. You know, our country GNP improved over the last 20 years three times; that is an improvement of currency converted into dollar.
Our lifestyle and quality of life hasn't improved. It is just a statistical, sort of, mirage, and China will experience the same thing. So ask us about the effect of strengthening the home currency and what it does. Strong companies will remain strong and weak industries will remain weaker, like our rice growers.
It is a good idea at that stage to think about Asian currency basket, maybe ASEAN, as the whole world is dominated in terms of reserve currency by the dollars and the Europeans talk about the Euro becoming strong, but it is a very small portion of the reserve currency, in the private and central bank's reserve currency.
What is the impact of floating Renminbi on Hong Kong? I think it is going to be, at least short term, very positive for Hong Kong because the Hong Kong dollar is pegged against the US dollar – or pound Sterling for that matter – through the bilateral agreement and they have to honor this for 50 years. Renminbi is likely to appreciate, though instability and uncertainty will increase also. Hong Kong becomes extremely competitive in service offering, particularly relative to China, and more visitors and buyers from China will occur.
And CEPA becomes extremely important if this is the case, because Hong Kong will become a quasi-OECD for China. In other words, Europeans, Americans and Japanese will all set up some manufacturing operations in Hong Kong or the New Territories and we can live with 30 per cent or less value added being considered as made in Hong Kong freely going in to China. Thirty per cent compared with the current tariffs into China directly is a bonus and therefore you will have a real gold rush of OECD expensive products all coming in for cosmetic value added – call it 30 per cent – and then gush into China directly, all via Hong Kong. Therefore the most important thing for Hong Kong is to cast this one in concrete, because Beijing, looking at that, will say "Ah, sorry, it is no longer CEPA", and, you know, "We set up this."
Beijing can change their mind, so Beijing's mindset could easily change to look at Hong Kong's success. Remember this was given to you as sympathy. "We have to, sort of, please Hong Kong" and so I would say this is my, sort of, one-sided analysis of why Mr. Tung Chee Hwa has mishandled the amendments. It unfortunately coincided with Wen Xia Bao's visit, gave the impression to the rest of the world at least they were imposed by Beijing.
Probably not. They had been working on this for a long time. The rest of the world does not understand what the colony's rules were like. In many ways it was more restrictive. There was the University of Nippon Alumni Association here in Hong Kong, and they were told by the British ruling government that such a party formation and secret meeting is not allowed under colony rule. So, you know, in those days there was not perfect freedom either.
The rest of the world also suspects Beijing will rule with an iron hand when "push comes to shove". It hasn't done so, but they suspect and therefore they fall prey to the CNN's of this world. They love to report misery in Hong Kong to the rest of the world. "Fifty million people on the streets of Hong Kong, wow, you know, up against Beijing", love it, and some Hong Kong people naively believe that they have won in 1997 freedom of everything, which to my knowledge no other country on earth will tolerate. Therefore you have to look at the amendments and see what is good for Hong Kong.
The lack of democracy in China is a fear, right? I don't think so. That's good. China is adapting a corporate model, as I said, of running the country with economic growth as the objective. Hence, there is no concept of democracy in the corporation. Mayors and governors are appointed by Beijing. This is like a company; CEO appoints head of the divisions and departments, and appointed by CEO and if you do not perform against the target – which is seven per cent per capita GNP rise – of the city this year, year in year out, one year missing the target is a yellow flag; two years is a red flag, you are out, sacked. I wish to import this system to Japan. All the mayors will be sacked next year.
Up to about $10,000 per capita, this is not a bad model. If the quality of life continues to improve for the majority of the Chinese people and the improvement of quality of life remains the top priority of the ruling party – because this is, after all, what democracy is all about, the majority happiness – and therefore whether you take the physical form of electing the head of the city, head of the government is immaterial, in my opinion. After $10,000 per capita GNP, they should do it because they are now well enlightened; they have so many different interests, therefore they can choose. But then when, sorry to say, like in California, when 100 candidates come up in the election, what does election mean in a true democracy? I have no idea.
Given this background, what are the options for Hong Kong? I would say Hong Kong could become one of many region states of the United States of Chunghwa. You like to be the region for China but I am afraid that other regions are equally strong and unique.
Or you could become a de facto capital of Guangdong. I don't know what people from Guangzhou will say to this, so good luck with this and also you could become what New York is for the United States. It is not the political capital of the United States, but it is everyone's recognition that that is the center of the universe. Or you could become a Bermuda or Monaco for Chinese and Japanese to hide money and do something tricky.
Or you could become a Mecca for Chinese for shopping and entertainment. Now this is what you are banking on today. Six million people are now coming and after SARS now 12 million this year; oh my goodness, and credit card through Great Wall Company, "Oh, wonderful, we accept anything". That is the attitude, right?
An offshore production site for OECD under CEPA. I think this option should be considered very seriously. These are the options that you could consider.
On the other hand, what are not the options for Hong Kong? Let me tell you this, as a student of regional economy and the world, this notion of Hong Kong against Beijing, Hong Kong versus Beijing, as if this were a country, Beijing is a country and the two centers competing for the ego is not a good model. China is many Hong Kong's already and therefore you could not take the 90 per cent share of the mind of the people in Beijing.
Another one is Hong Kong as a free port. That is wrong. Anything goes in China today. You know, this – 
Colonizing Guangdong as a capitalist. Some people have this attitude. I think it is wrong. Guangdong as customers who are equal partners at best. This attitudinal change is very important and they will see who are treating them as true partners.
Another possibility is port of entry to China on behalf of the rest of the world will also not work, because today direct access through a dozen coastal cities is possible and particularly when Taiwan exchanges the (san tong) with the Mainland, many of the things that went through Hong Kong will disappear.
Symbol of free market and freedom and democracy because we choose the head of administration by vote: I have to ask you, when you have become religious? There is no value and no money in this approach, let alone for Hong Kongers to keep today's per capita income. So Hong Kong has to be very pragmatic in terms of competitive position, not just "Oh, we have democracy, they don't".
Here is an example of Pusan becoming the focal point for Yellow Seas. For Shenyang, Daoyang and Beijing, Tianjin and Yantai and Tsingtao, all these tax free zones produced by the Japanese and the Koreans go on the carrier, small carrier to Pusan, and from there they are converted into Korea's export on the ^ carriers to north America and Europe.
In other words, like Hong Kong is acting on behalf of Guangdong, Pusan is acting on behalf of part of Japan and for most Korean companies. These are exports of Korea, but actually manufactured in China and when Kaohsiung becomes such a place on behalf of Fujian this will be also a huge minus for Hong Kong as a trading hub in this region. Okay, so you have to think ahead about the role of Hong Kong as a hub for the containers.
So, finally, my recommendation for Hong Kong is for you to build strategy on reality. The reality I can trust is the bilateral agreement and currency will help because this agreement, pegging HK$7.8 to the dollar to 50 years in the future, is an extremely stable and reliable contract, so long as you adhere to it, or Beijing adheres to it.
Enforce CEPA and cast it into at least a 10-year contract so that Beijing doesn't change their mind and invite investment using Hong Kong as a base for value added trade. This is going to be enormous and just about everyone I know of will come to Hong Kong for this cosmetic 30 per cent and it will help.
Treat upper-middle class Chinese as target customers. Go beyond Beijing and regional government and establish direct access to individuals. This will be the first CRM strategy in China. Treat the individuals. As you know, 12 million Chinese tourists will come to Hong Kong. Do you know them by name, by address, by telephone numbers, etc? You have to know them. Create a database and develop attractive financial products and services they can certainly afford. The top one per cent has enough purchasing power, top ten per cent of China today has affluence and it will grow, particularly when the Renminbi is floated, it will have a tremendous purchasing power.
Direct marketing of made-in-Hong Kong, OECD goods, as Spain is doing for Europe and Italy is doing for the world. Frequent visitor program with ease of travel and access and payment, as in Great Wall's credit card, and offer similar but differentiated services to the Japanese, who are living in a very controlled financial, and otherwise, market situation, and this will be a fantastic service venue that you can offer.
Hong Kong people tend to treat customers with commercial interest. When the Japanese are flooding into Hong Kong they purposely raise the hotel rates for the Japanese tourists only and that is why they are now exiting out of Hong Kong; they don't like this attitude. They have to be treated like customers. They are treated like a rip-off target and therefore I hope the Tourist Bureau, some oversight committee will be formed to say you have to treat all customers equal; you have to treat visitors as customers. You don't have this discipline. When everything is good you take advantage of them. This image of Hong Kong has to change.
And become also a hub for professional services. Many people in this room offer professional services. China needs professional services. I am a lifelong consultant and consulting, engineering, evaluation, environmental evaluation, etc all these professional services are needed by these cities – 166 cities in China – they don't have this professional infrastructure. Hong Kong could be the hub for the dispatch of these professional people, because this is, after all, the best place to live and therefore even Japan – which is the second largest economy – in 50 years time, 2050, will become ten per cent of China and this is forecastable because of the demography of Japan, demography of China, demography of the United States, and therefore unless we internalize China, the Japanese corporations in Japan, itself, cannot survive.
The question is can you become an isolationist Hong Kong and survive? I would have to suggest that you have to internalize China and treat them as your best partner and customer, and you have to know them by name – not by their statistical numbers, but by name, telephone numbers, and internet addresses, etc. CRM is the key word.
Thank you very much.
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