Will Shanghai overtake Hong Kong to be China's largest financial center?
Will Shanghai overtake Hong Kong to be China's largest financial center?
It could very well be neither
By framing the question to be specifically about Shanghai and Hong Kong only, you might miss another leading contender. You see, in the long run this won’t be as much a competition between Shanghai and Hong Kong as it will be a “Battle of the Deltas” i.e. between the Yangtze River Delta and the Pearl River Delta.
Frankly, I think it is a toss-up at this point, but if forced to choose, I would say the Pearl River Delta emerges as the ultimate winner. But if the PRD wins, it will not be the present manifestation of Hong Kong that wins the title of “China’s leading financial center”, but what is ultimately a combined Shenzhen-Xianggang megalopolis.
Whither Shenzhen?
Shenzhen’s always been a bit overlooked. A little over three decades ago, Shenzhen was a small fishing village. In 1980 it was designated as a Special Economic Zone and started to industrialize. In 1992 Deng Xiaoping made his “Southern Tour” and cemented Shenzhen’s place in history. Leveraging its close geographic and cultural proximity to bustling Hong Kong, Shenzhen grew rapidly and is today a city of 15 million with per capita GDP on par with China’s other Tier I cities (e.g. Beijing, Shanghai, Guangzhou).
People often forget that Shenzhen is a regional financial center and home to the Shanghai Stock Exchange’s little sibling. The Shenzhen Stock Market is ranked #9 in the world (Shanghai is #7 and Hong Kong is #6) in terms of market capitalization. And if you were to combine Hong Kong and Shenzhen, it would be #3 in the world after the NYSE and Nasdaq. More important than these rankings, the key point here is the Shenzhen has enough critical mass as a current Chinese domestic financial center to go head to head with Shanghai and paired with Hong Kong, it adds something that Shanghai does not have today, namely international finance.
Who will lead China’s New Economy?
Having the largest, most dynamic regional economy will be an important factor in determining who gets to be China’s leading financial center.
As many people know, China is currently undergoing major changes in its economic structure. It can no longer depend heavily on fast-growing exports or fixed asset investment to drive most of its growth. As a result, to scale the next few rungs of the economic ladder and attain high income status over the next decade or two, China really has to depend on its internal markets and domestic consumption to drive growth. And in China’s post-industrialization “New Economy” phase, innovation and entrepreneurship are increasingly important.
The economies in the Shanghai cluster and the Pearl River Delta have followed different paths to get to where they are today. Shanghai industrialized relatively early and its industrial economy was state-dominated when the economic reform period arrived in the late 70s. Today, the quasi-state conglomerates continue to play a major role in Shanghai’s economy.
Far from China’s political center, Guangdong Province had always been considered by many as somewhat of a frontier province. As such, it was not a coincidence that Deng Xiaoping chose the province to experiment with his economic reforms. At the time, it was still largely an agrarian-based economy with relatively little in terms of established academic/research institutions or an industrial base.
These distinctions became important during the economic reform period as capital and know-how started to flow first into the Pearl River Delta. Tens of thousands of export-oriented factory owners in HK moved their operations across the border to tap into the massive labor pool pouring out of the countryside. With existing trade links to the developed world, the seeds were sewn for the rise of what is now a massive export-oriented manufacturing base spanning large swathes of the Pearl River Delta, centered around Shenzhen and its satellite cities. Importantly, unlike Shanghai and its large quasi-state conglomerates, these exporters were predominantly private enterprises run by hungry, hustling entrepreneurs.
Shenzhen and Guangdong Province started with very little and thus the only way companies could succeed was by hustling and being entrepreneurial. As such, it doesn’t surprise me that many of China’s most dynamic and globally competitive companies have emerged out of this cauldron. While there are certainly many innovative companies in Beijing and Shanghai, in my view the highest concentration of them are in Shenzhen and the Pearl River Delta region [1]. And I believe that this environment of private enterprise, competition and entrepreneurship will allow Shenzhen and Pearl River Delta to take a leading role in China’s New Economy in the coming years. [2]
Mergers & Acquisitions
China agreed to a 50-year handover period because that was – in their minds – a reasonable amount of time for the mainland to converge (economically, perhaps institutionally as well) with Hong Kong. Seventeen years in, China appears to be making good progress towards that goal, with per capita GDP rising from 7.5% of Hong Kong in 1997 to 21% in 2014 [3]. As we march towards the 2047 milestone date, detailed integration plans will be drawn up to integrate legal systems, administration etc. The critical issue here as it pertains to the question is how this integration is done – namely, will Hong Kong look more like a mainland Chinese city today or will mainland Chinese cities have “caught up” to look more like Hong Kong.
Already, the two cities [4] are in the process of integrating. In 2008, the government unveiled a plan to merge the entire region and the blueprint proposed investing in major infrastructure projects including transportation (high-speed rail links), water supply, energy and communications. For example, when the Express Rail Link is completed in 2017, you will be able to traverse the Delta going 90 miles from downtown Hong Kong north to downtown Guangzhou in less than 50 minutes, or about the same amount of time it takes to get from Flushing to the Financial District. If current trends persist, by 2030 the combined megalopolis would include over 60 million people with an economy roughly the size of today’s United Kingdom.
By 2047, autonomous “Hong Kong” as we know it will not exist. And for long-term questions such as this, one really ought to think about Hong Kong, or (perhaps at that time more appropriately) Xianggang, in the context of its eventual merger with the rest of the Pearl River Delta – and especially with Shenzhen.
Of course, it always comes down to politics ...
Ultimately it will come down to politics. I have no special insight into the CCP’s decision-making process, especially for a decision that very likely doesn’t need to be made for many years. That said, I do think that the CCP is currently perfectly satisfied with the status quo of having two dueling financial centers (Shanghai and Shenzhen) and they still have another three decades to work on integrating Shenzhen and Hong Kong. In any case, China has a long history of allowing individual regions compete with each other and the Shanghai vs. Shenzhen stock market case is just another example of that.
Alongside Beijing, the Yangtze River Delta and Pearl River Delta are equally important and command roughly equal levels of political power. For example, a lot of Xi Jinping’s power comes from the fact that he has significant support from all three of those regions while previous leaders only had a power base in one or two.
I am sure the Shanghai contingent of the CCP would love to see Shanghai emerge as the sole winner. In fact, they won an important battle recently with the establishment of the first direct trading link between Hong Kong and Shanghai. That said, out of the “Big Three” Chinese Internet companies, Shenzhen-based Tencent managed to obtain the first banking license. So score one for the PRD. But I think what this says is that the PRD and Shanghai contingents have roughly equal amounts of political power within the party ... as well as that perhaps the Beijing contingent doesn’t want to see too much financial power controlled by one rival Tier I region. And maybe, just maybe the PRD folks understand that, done right, integration with Hong Kong just might shift the balance in their favor ... again, just speculating here.
Eventually a decision will be made. But keep in mind that the decision could very well be to have two major financial centers, perhaps with complementary specialties. As I wrote in the beginning, I think it’s a toss-up and perhaps the most likely scenario after all is for the two major financial centers to co-exist.
Notes
[1] For example: BYD, which started as a battery company and is now China’s leading electric vehicle manufacturer; Huawei, the world’s largest and most profitable communications equipment manufacturer and services provider; and Tencent, of Wechat fame and one of China’s “Big Three” Internet companies (alongside Alibaba and Baidu).
[2] For much more on this, I recommend reading Run of the Red Queen which discusses the starting conditions (namely, that the region started with very little outside of inexpensive labor, geographic proximity to Hong Kong and a large Chinese diaspora) that have led to the Pearl River Delta having a very much more entrepreneurial community and, likely in the future, China’s most dynamic and ultimately valuable companies.
[3] China is not as far behind Hong Kong as the 21% figures suggests, as we are comparing a large country to a wealthy, highly urbanized and international city. Shanghai’s per capita GDP, at around 2.2x that of mainland China, means that China’s 2nd-wealthiest Tier I city is a little less than half of Hong Kong’s.
[4] In fact, the entire Pearl River Delta, all the way up to Guangzhou and going back down the western bank of the Delta to include Zhongshan and Zhuhai. I guess you might as well throw Macau in there as well.
This was originally published on Quora in November 2014.