Hong Kong-U.S. Economic Relations

CRS Report for Congress
Hong Kong-U.S. Economic Relations
Wayne M. Morrison
Specialist In International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Hong Kong is described by many observers as having the world’s freest economy
due to its low tax, free trade, and strong rule of law policies. Hong Kong is an important
U.S. trading partner and serves as a gateway for many U.S. companies doing business
in China. For those reasons, the continued economic autonomy of Hong Kong is of
concern to Congress, as are a variety of trade issues such as the effectiveness of Hong
Kong’s export control regime on dual-use technologies, and protection of U.S.
intellectual property rights. China. This report will be updated as events warrant.
Hong Kong is often characterized as the “world’s freest economy” due to its strong
rule of law, low tax and tariff rates, and minimal government interference in the1
economy. Once a colony of Great Britain, Hong Kong was returned to Chinese
sovereignty in July 1997 under an agreement that made it a “Special Administrative
Region” (SAR) of China, a status that basically guarantees Hong Kong’s economic and
political autonomy for 50 years. Most observers contend that, to date, China has generally2
refrained from interfering in Hong Kong’s economic affairs.
Hong Kong’s Economy
With a population of 6.8 million, Hong Kong is one of the world’s most vibrant
economies and a major center for international banking and foreign trade. It is utilized
by many foreign companies as a gateway to markets in mainland China. With a per
capita GDP of $27,700 on a purchasing power parity basis in 2003, Hong Kong maintains
the second highest standard of living in Asia (after Japan); it is higher than that of many
West European nations, including Germany and the United Kingdom. Hong Kong is a
member of a variety of multilateral economic organizations, such as the World Trade
Organization (WTO) and the Asia Pacific Economic Cooperation (APEC) forum.

1 See the Heritage Foundation 2005 Index of Economic Freedom, available at
[http://www.heritage.org/ research/features/index/].
2 However, some analysts contend that in some instances, China has attempted to interfere with
certain aspects of Hong Kong’s political and judicial systems.
Congressional Research Service ˜ The Library of Congress

Hong Kong’s economy is heavily dependent on trade.3 In 2004, Hong Kong’s
merchandise exports and imports were $259 billion and $271 billion, respectively. A
large share of Hong Kong’s trade consists of entrepot and processing trade, much of it
involving China.4 About 30% of China’s trade passes through Hong Kong. Taiwan,
which does not maintain direct commercial links with China, ships most of its exports to,
and imports from, China via Hong Kong. A large share of China’s exports also pass
through Hong Kong before being re-exported to other destinations. Some of this trade
consists of products made by Hong Kong firms in the Mainland, which are sent to Hong
Kong for further processing before being re-exported elsewhere. Hong Kong has
transferred a large share of its manufacturing base to the Mainland. In the Pearl River
Delta region (Guangdong Province, China), 50,000 Hong Kong firms employ about 6
million Chinese workers, 20 times the size of Hong Kong’s manufacturing workforce. As
a result, the importance of manufacturing to Hong Kong’s economy has diminished in
recent years, while that of services (especially those relating to trade, such as banking and
financial services) has increased sharply. In 2004, services exports and imports were
estimated to total $65 billion and $36 billion, respectively.
Recent Economic Challenges
Hong Kong has enjoyed relatively healthy growth over the past several years.
However, in 1997 Hong Kong’s economy was hit by the Asian financial crisis. Beginning
in July 1997, speculative pressures on the Hong Kong dollar (which has been pegged to
the U.S. dollar since 1983) caused the Hong Kong Monetary Authority (HKMA) to spend
$1 billion to prop up the currency. These pressures continued, leading the HKMA in
October 1997 to raise interest rates (to stop capital flight), which subsequently led to a
nearly one-quarter drop in the Hong Kong stock market (the Hang Seng Index) over a
four-day period. In late August 1998, the Hong Kong government intervened in the stock
market’s decline by spending $15 billion to purchase shares from 33 blue-chip companies
that make up the Hang Seng Index, which helped raise the value of the shares by 24%.
Several analysts criticized the government’s intervention, arguing that it violated Hong
Kong’s free market principles by increasing the government’s role over the economy.
The Hong Kong government maintained that its intervention was a one-time event,
intended to halt speculation and stabilize the stock market.5
The effects of the Asian economic crisis on Hong Kong were significant. The
economy fell into a major recession in 1998: real GDP fell by 5.0%, the unemployment
rate rose from 2.2% to 4.7%, and exports and imports declined sharply. The Hong Kong
economy recovered somewhat in 1999 and 2000, but was negatively affected by the
terrorist attacks against the United States in 2001 and by the outbreak and spread of a new
and deadly virus called Severe Acute Respiratory Syndrome (SARS) in 2003. Hong Kong
was one of the areas hardest hit areas by SARS, which drastically reduced tourism and
domestic demand. By the end of June 2003, the unemployment rate rose to a record high

3 According the Hong Kong Trade Development Council, Hong Kong is currently the world’s
eleventh-largest trading economy and the tenth-largest exporter of services.
4 In 2004, 94% of Hong Kong’s exports were re-exports, i.e., products that were imported into
Hong Kong and re-shipped elsewhere.
5 In 1999, the Hong Kong government began to divest itself of many of these shares.

8.7%. Hong Kong’s economy picked up sharply in 2004, due to rising exports and strong
domestic demand. Real GDP grew by an estimated 7.7%; however, unemployment
remained stubbornly high (see Table 1)
Table 1. Selected Economic Data for Hong Kong, 1997-2004*
1997 1998 1999 2000 2001 2002 2003 2004*
Annual Real GDP5.1-5.03.410.
Growth (%)
Unemployment rate (%)
Nominal GDP174165161165164162158165
( $ b illio ns)
Merchandise exports191173173202190200223259
( $ b illio ns)
Merchandise imports209183179213201208232271
( $ b illio ns)
*Data for 2004 are estimates. Date on unemployment is average of the last three months ending in
November 2004.
Sources: Hong Kong Trade Development Council, Hong Kong Census and Statistics Department, the
Economist Intelligence Unit, and Global Insight.
Hong Kong-U.S. Economic Ties
The United States is one of Hong Kong’s most important economic partners. In

2003, the United States was Hong Kong’s largest market for domestic exports (i.e.,

products made in Hong Kong) and its fourth-largest supplier of imports. There are over
1,000 U.S. businesses represented in Hong Kong, including more than 400 regional
operations; more than 50,000 U.S. citizens reside in Hong Kong. Cumulative U.S.
foreign direct investment (FDI) in Hong Kong at the end of 2003 was $44.3 billion.6
Many U.S. firms and investors seeking to do business in China have used Hong Kong as
a base for their operations, frequently relying on Hong Kong partners to obtain the
“guanxi” (connections) that are often needed to gain access to China’s markets.
In 2004, it is estimated that Hong Kong was the thirteenth-largest purchaser of U.S.
exports ($16.0 billion) and the twenty-seventh-largest supplier of U.S. imports ($9.3
billion). The top three U.S. exports to Hong Kong in 2005 were electrical and electronic
machinery and parts (mainly electronic integrated circuits, micro-assemblies, and
semiconductors), non-electrical machinery (such as computers and computer parts), and
miscellaneous manufactured items (mainly diamonds and jewelry). The top three U.S.
imports from Hong Kong were apparel and clothing, miscellaneous manufactured
commodities, and telecommunications and sound equipment (see Table 2).

6 The American Chamber of Commerce in Hong Kong argues that this figure significantly
understates the actual level of U.S. FDI in Hong Kong because it reflects only FDI reported by
U.S. parent companies of subsidiary corporations in Hong Kong but not individual U.S. investors.

Table 2. Major U.S.-Hong Kong Trade Commodities, 2000-2004
($ in billions)
Y e ar 2000 2001 2002 2003 2004
Total U.S. Exports to Hong Kong 14.614.112.613.516.0
Major U.S. Exports to Hong Kong
Electrical and electronic machinery, equipment3.
and supplies
Non-electrical machinery (e.g., computers)
Miscellaneous manufactured articles (mainly0.
Total U.S. Imports From Hong Kong11.
Major U.S. Imports From Hong Kong
Apparel and clothing products4.
Miscellaneous manufactured commodities
Telecommunications and Sound Recording and0.
Reproducing Apparatus and Equipment
SITC Classification, two-digit level.
Source: U.S. Commerce Department. Date for 2004 estimated based on actual data for Jan.-Nov. 2004.
The United States continues to treat Hong Kong as a separate economic territory for
such purposes as trade data and export controls. U.S. officials continue to work with
Hong Kong officials to ensure that Hong Kong is not used by China to illegally
circumvent U.S. controls on exports of dual-use and other high technology products and
to combat violations of U.S. intellectual property rights (IPR) in Hong Kong.7
Export Controls. The United States seeks to control exports of dual-use
technologies for a variety of national security and foreign policy purposes through a
complex regulatory system of export license requirements. Despite the reversion of Hong
Kong to Chinese sovereignty, the United States continues to treat Hong Kong separately
from the Mainland for export control purposes (i.e., controls of U.S. exports of dual-use
items to Hong Kong are far less restrictive than those to China). Some Members of
Congress have raised concern that China may be using Hong Kong to acquire dual-use
items that cannot be obtained directly from the United States, and have called for tighter
controls on U.S. exports to Hong Kong.

7 U.S. and Hong Kong officials also cooperate on a variety of other matters, such as terrorism,
alien smuggling, money-laundering, counterfeiting, organized crime, and drug trafficking.

The United States-Hong Kong Policy Act of 1992 (P.L. 102-383) requires the U.S.
State Department to report periodically to Congress on conditions in Hong Kong and its
relations with the United States, including cooperation in the area of export controls. In
its most recent report (April 2004), the State Department stated that “Hong Kong
maintains an effective, highly autonomous, and transparent export control regime that the
U.S. government has encouraged others to emulate.” However, the report stated that the
growing economic integration between China and Hong Kong has presented new
challenges to ensure effective compliance with export control regimes, and noted that
over the past two years, inspections have uncovered an increase in instances of illegal re-
exports of U.S. dual-use technology to China. Hong Kong and U.S. officials have agreed
to boost cooperation on the sharing of licensing and enforcement information and to
education the Hong Kong public of export control laws.8
IPR Protection. Over the past few years, the United States has pressed Hong Kong
to improve its IPR protection regime. From April 1997 to February 1999, Hong Kong
was designated by U.S. Trade Representative (USTR) under Special 301, (a provision of
U.S. trade law dealing with countries that violate U.S. IPR) as a watch list country due
to the widespread distribution and retail sale in Hong Kong of pirated compact discs.9
Hong Kong was removed from the Special 301 watch list after the USTR determined that
Hong Kong had made significant improvements to its legal regime and enforcement
efforts. The 2001 and 2002 Special 301 reports listed Hong Kong as one of several
trading partners in which progress in protection of IPR had been made. The USTR’s 2003
IPR report praised the Hong Kong government for requiring government agencies to use
only legitimate software and for its commitment to halt optical media piracy. The 2003
State Department report stated that Hong Kong had “shut down virtually all large-scale
illicit manufacturing lines,” but noted deficiencies in two areas: commercial end-use10
piracy and patent projection for pharmaceuticals.
Hong Kong’s Economic Future
Several international economic forecasting organizations contend that the long-term
prospects for Hong Kong’s economic future remain relatively positive, provided that it
continues to employ free trade, market-oriented policies, and maintains its autonomy from
mainland China.11 The Economist Intelligence Unit projects that Hong Kong’s economy

8 U.S. Department of State, United States Hong Kong Policy Act Report, Apr. 1, 2004, p. 7.
9 Under the Special 301 provisions, the USTR annually issues a three-tier list of countries judged
to have inadequate regimes for IPR protection or that deny market access: priority foreign
countries (considered the worst violators of U.S. IPR and are subject to possible U.S. trade
sanctions; priority watch list countries (considered to have serious deficiencies in their IPR
regime, but do yet warrant trade sanctions); and watch list countries (identified because they
maintain IPR practices of particular concern, but do not yet warrant higher-level designations).
10 U.S. Department of State, United States Hong Kong Policy Act Report, Apr. 1, 2004,p. 6.
11 A major area of contention concerning Hong Kong’s autonomy arose in July 2003, when the
government tried to pass an anti-sedition law (known as Article 23 proposals), which, many

will grow by 4.7% in 2005 and 3.6% in 2005, while Global Insight projects real GDP
growth at 4.9% and 4.4%, respectively.12
China’s accession to the WTO (which occurred in December 2001) poses both
opportunities and challenges to Hong Kong’s economy. On the one hand, the removal of
trade and investment barriers by China will likely significantly boost Hong Kong trade
with, and investment in, the Mainland. Hong Kong is already by far the largest investor
in China (and China is the largest investor in Hong Kong), and hence is likely to be in the
best position to take advantage of a more open Chinese market. In addition, China’s
WTO accession is expected to sharply increase its trade flows, and much of that increased
trade will likely take place via Hong Kong.13 On the other hand, a more open Chinese
market could diminish Hong Kong’s role as a middleman for foreign firms wanting to do
business with the Mainland, especially if foreign investors believe that the rule of law,
rather than “connections,” will be the primary factor governing business relations in
China. Hong Kong’s economy could also be negatively affected if China and Taiwan
decide to establish direct trade links, which would likely reduce the level of trade that
takes place via Hong Kong.14

11 (...continued)
critics contended, was being pushed by Beijing in order to undermine civil liberties in Hong
Kong. The relative secretness of the contents of the bill (and concerns over a number of other
political and economic issues) sparked a massive demonstration in Hong Kong on July 1, 2003,
with an estimated half a million participants, forcing the government to withdraw the bill. A
second major autonomy issue arose in April 2004 after the Chinese government declared that
political reforms in Hong Kong would have to meet Beijing’s approval. See CRS Report
RL31185, China-U.S. Relations: Current Issues During the 108th Congress, by Kerry
12 Economist Intelligence Unit, EIU Country Indicators; and Global Insight, Hong Kong: Interim
Forecast Analysis, September 2004.
13 In June 2003, China and Hong Kong signed a free trade agreement, a move that is likely to
deepen their economic integration. In addition, the Chinese government in 2003 relaxed a
number of restrictions on mainland residents wanting to visit Hong Kong, which has helped to
boost Hong Kong’s tourism industry. In 2003, more than half of all tourists visiting Hong Kong
were from the mainland.
14 Taiwan joined the WTO in January 2002. WTO rules may require Taiwan to end its ban on
direct trade links with the Mainland.