Hong Kong’s special status is hanging by a thread

Anti-government demonstrators gather to protest in Central, Hong Kong, China November 14, 2019. REUTERS/Athit Perawongmetha – RC2TAD9B53WZ
Anti-government demonstrators gather to protest in Central, Hong Kong, China November 14, 2019. REUTERS/Athit Perawongmetha – RC2TAD9B53WZ
Image: Reuters/Athit Perawongmetha
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Hong Kong has long occupied a peculiar place in the international economic order. It’s not an independent country, but can enter trade agreements with other states on its own. It sets its own taxes, and has its own currency. Though it’s part of China, tariffs and customs controls applied on Chinese goods don’t apply to Hong Kong.

But Hong Kong’s special status is now facing its most urgent crisis yet. Following Beijing’s announcement last week that it would bypass all of Hong Kong’s legislative procedures and unilaterally enact a sweeping national security law by fiat, countries are re-evaluating whether the city should continue enjoying its special trade privileges, or be treated as just another mainland Chinese city.

In a statement yesterday, US secretary of state Mike Pompeo declared that Hong Kong can no longer be deemed to have a high degree of autonomy from China.  This designation underpins US-Hong Kong relations, as Washington has legislated that the city must remain “sufficiently autonomous” to justify special treatment from the US.  On Tuesday (May 26), president Donald Trump said he would announce a strong response to Beijing’s actions over Hong Kong this week, adding that it’s “hard to see how Hong Kong can remain a financial hub if China takes over.” US senators have already introduced a bill that would impose sanctions on Chinese officials and firms who violate freedoms in Hong Kong.

The devil is now in the details. The US could impose targeted sanctions and roll back certain privileges. Or it could deploy arguably its most aggressive retaliatory tool and revoke Hong Kong’s special trade status. This is often referred to as the “nuclear” option, and would be hugely damaging not just to Hong Kong’s economy, but also a lot of US businesses. A senior US state department official said yesterday that Washington’s response to Beijing will try as much as possible to “mitigate the impact globally on the Hong Kong people” and to sanction China in a “smart” way.

“I don’t think the US will revoke Hong Kong’s special status if it has any other option available, because once that happens, the US has very little leverage left over China on Hong Kong,” said Julian Ku, a professor at the law school of Hofstra University in New York. He thinks it’s more likely that the US would terminate particular treaties or laws that treat Hong Kong as an entity separate from China. “So we could imagine the president deciding to treat Hong Kong the same as the [People’s Republic of China] for tariff purposes only, but not for the purposes of export controls, or vice versa,” he said.

The US has a sizeable presence in the Hong Kong economy. It has the highest number of regional headquarters and offices in the city. Almost one-third of the city’s restricted license banks—those that mainly deal with merchant banking and capital market activities—are owned by US interests. It is also Hong Kong’s second-largest trading partner, after China, accounting for 6.2% of the total share. And in 2018, 8% of China’s exports to the US, worth $37 billion, were routed through Hong Kong, according to the city’s trade and industry department. The US is also the single economy with the largest trade surplus with Hong Kong, at over $33 billion in 2018. Scrapping Hong Kong’s trade status would jeopardize all of that, and more.

Several prominent voices, including Republican senator Marco Rubio and veteran diplomat Richard Haass, have already called on the US to revoke Hong Kong’s special status. Such a move would be “less about punishing China and more about being honest about the unavoidable consequences of Hong Kong no longer being different from the rest of China, if that becomes the case,” said Patrick Chovanec, an advisor at Silvercrest Asset Management and an expert on the Chinese economy.

China has threatened the US with countermeasures if Washington decides to punish Beijing for its plans to enact the national security law, saying other countries have no right to interfere with Hong Kong’s internal affairs. Some Hong Kong politicians, including the pro-Beijing lawmaker Regina Ip, have tried to dismiss the prospect of US sanctions by saying they wouldn’t affect the local economy very much. Daniel Fung, a Hong Kong barrister and a national delegate to the Chinese People’s Political Consultative Conference, said“it’s premature to talk about revocation of status or to elevate this to the level of an iconic crisis.” 

Others think the US is bluffing. “Last I checked, the US is enjoying a $31 billion trade surplus [in merchandise trade] with Hong Kong, so any serious disruption such as the revocation of trade status will harm the US more,” said Songnian Chen, a professor of economics at the Hong Kong University of Science and Technology. Though Hong Kong would be badly hurt if it were to lose its special status, he added, China would just come out stronger. “As long as there are profits [in China] to be made, capital is a lot smarter than politicians and opinion leaders, and will find its way there.”

That might be an optimistic outlook, given that Hong Kong continues to be an important part of China’s economy. While the size of Hong Kong’s economy is equivalent to less than 3% of that of China’s, its unique legal and financial systems means it plays an outsize role in attracting international capital to China. More than 60% of all foreign direct investment in China was channelled through Hong Kong as of 2018, according to China’s national statistics. The city is also a big depository of assets, with Chinese banks holding more assets in Hong Kong than lenders from any other region, according to data from the Hong Kong Monetary Authority.

Any sudden disruption to this set-up could unleash unpredictable ripple effects across China’s financial system.  But Chovanec pointed out that even without the US imposing sanctions, China’s undermining of Hong Kong’s autonomy is already enough to destroy global confidence in the city’s legal and financial systems.  “Beijing is killing the goose that lays the golden eggs,” he said. “Its own goose, not a US goose.”