In May 2020, the National People's Congress of China passed the draft of the National Security Law of Hong Kong, which severely restricts the democracy of the Hong Kong Special Administrative Region and has triggered a crisis of international sanctions. This wave of tightened political control is bound to make an impact at the economic level. The impact on Hong Kong's trade was analyzed in another article a few days ago ("US Sanctions Strategy Should Be Correct to Protect Hong Kong's Autonomy "). There have been discussions in the finance industry about the possibility of transferring Hong Kong's financial realm to other countries in Asia, and proponents have also been discussing whether it is time for Taiwan to grab the opportunity to relocate financial institutions from Hong Kong to Taiwan, and fulfill Taiwan’s dream of being the "Asian-Pacific financial hub".

There are four main reasons why Hong Kong gradually became a global financial center after World War II. Firstly, Hong Kong adopts the English Common Law system, which is the same as that of the other three global financial centers in New York, London and Singapore. With English as Hong Kong’s common language, there is no difficulty in communicating with these markets. According to empirical financial and economic research, it is generally agreed that the common law system guarantees the protection of property rights and the efficiency of law enforcement is higher than other legal systems.

Considering the risk of possible changes in foreign exchange

Secondly, China's massive real economy and international trade as well as financial transactions with foreign countries have created demand for financial services (such as IPOs and corporate mergers and acquisitions). In particular, prior to China joining the World Trade Organization, Hong Kong was an exclusive buffer and window for China's interactions with the outside world. To this day, more than 90% of Hong Kong listed companies are Chinese companies or companies that actually operate in China, and Hong Kong’s myriads of international financial institutions provide wealthy Chinese people with international transactions that are convenient with a high degree of privacy.

Thirdly, Hong Kong’s taxation system is simple. Both personal income tax (tax rate increased to 17% in 2020) and corporate income tax (tax rate increased from 15% to 16.5% in 2020) are lower than most highly developed countries, with a simple company registration process. For many years, Hong Kong and Singapore have been rated as countries with the highest degree of economic freedom in the world (evaluation criteria may not be related to politics or personal economic freedom).

Finally, the Hong Kong dollar adopts a fixed exchange rate pegged with the US dollar (US$1 = HK$7.8), freeing international investors from worries about exchange rate risk. But Hong Kong has to pay a price, which is to give up its autonomy to manage its monetary policy. However, this fixed exchange rate policy is also facing considerable challenges as the Hong Kong economy becomes increasingly close to China. As far as investors are concerned, as long as the exchange rate is relatively stable, adopting a fixed rate is not necessary, and they are quite willing to invest, because they will incorporate the risk of possible changes in foreign exchange into their investment function. In this regard, Taiwan still has considerable advantages.

International capital is concerned about the rule of law and transparency

For a long time, Hong Kong’s high per capita national income has been envied by some people. This is a result of Hong Kong’s special position as a “city state” as mentioned above, with its economic structure dominated by tertiary industries, coupled with a division of labor in international trade with China, whose huge economy used to be a closed economy acting as a “back factory” while Hong Kong acted as its “front store”. All these factors are difficult to come by in most countries of the world.

If a country wants to "make big money", it has to change its system and economic ecology into another Hong Kong model, which is like cutting one’s toes to fit one’s shoes. A legal system has a deep-seated relationship with history and culture. To avoid social turbulence, it may take several generations to change. Although Taiwan adopts the Mainland’s legal system, some commercial laws and intellectual property rights laws came in later, which were considerably influenced by the US. Appropriate adjustments in laws and regulations can also make up for the shortcomings relative to the Anglo-American legal system. However, the problem still lies in the mentality, not at the legal level.

In addition, countries that have a considerable scale of primary and secondary industries will have a complex economic structure. Thus, it is almost impossible for them to employ a single (and lower than most countries) tax rate and give up the autonomy of managing its monetary policy. The "Anti-extradition Bill Movement" in 2019 and the "Hong Kong version of the National Security Law" in 2020 have brought about controversy and confrontation that have greatly challenged Hong Kong's status as an international financial center; but the international capital industry is concerned about Hong Kong's "rule of law and transparency" instead of Hong Kong's "democracy and human rights" (although in practice the two are actually related). As long as there are no major changes in Hong Kong’s capital inflows and outflows, taxation systems, listing regulations and other financial regulations, Hong Kong’s status is still hard to shake.

On the other hand, if Taiwan can grasp what financial services Taiwanese businesses need in this changing situation, Taiwan can obtain considerable growth opportunities. The implementation of the National Security Law has greatly intensified Hong Kong’s political risk. In addition, the efficiency of China’s law enforcement is hardly complimented by foreign investors. Moreover, China takes a negative attitude towards Taiwan’s sovereignty and laws, and the protection of Taiwan investors’ property rights is deteriorating. As international investors’ first investment rule is "Do not enter dangerous states and do not live in chaotic states ", in the foreseeable future, a considerable number of Taiwanese businesses (and even Hong Kong businesses) will come to Taiwan to avoid risks. Since Taiwan already has democracy and the rule of law, as long as it is more transparent, it can achieve an advantage similar to that of Hong Kong.

If this backflow of living waters is introduced into the investment of the real economy and the energy obtained from finance is used to support the industrial development, it can help boost Taiwan's productivity. In addition, if these Taiwanese-funded enterprises leave China to invest in other emerging markets (especially in Southeast Asia), they can also provide potential customers for Taiwan's financial institutions.

An international center does not meet overall interests

Globally, the objectives of major advanced countries focus mostly on the sustainable development of the real economy, and becoming an international center for a certain service industry may not fit its overall interest. A city with an international financial center is often also a place where headquarters of multinational companies and large international financial institutions are set up. It does not only meet the huge capital financing needs (for its non-residents), but also comes with an open and active foreign exchange market, stock market, derivatives market, with a legal system and trading system in line with that of the international community, and needs to be equipped with convenient transportation, international professional education, and other software and hardware infrastructure. The hardware and software facilities required for the development of the aforementioned financial center are still quite far away from Taipei, and they may not be able to catch up in the medium term.

The division of labor in economic development in a region arises naturally as each industrial sector grows. If a country exhausts all its efforts with the intention of replacing other financial centers, such as Seoul in South Korea or Beijing and Shanghai in China, the country may be able to surpass Hong Kong in numbers, but is still incompetent to compete head-on with Hong Kong.

Striking a balance between financial stability and growth

In Western Europe, London after Brexit remains as the leader in Europe’s financial markets. London is situated at the center of the Greenwich time zone. It trades foreign exchange with the eastern hemisphere for 12 hours a day and another 12 hours with the western hemisphere. Its unique geo-economic factors are unique advantages that other cities cannot replace. Nor has Europe seen a manufacturing-oriented economy, such as France and Germany, pursuing to develop Paris and Frankfurt to replace London as a financial center. According to the 2020 Global Financial Centers Index, the development of Paris and Frankfurt even lagged behind cities like Shenzhen and Dubai, but this does not undermine the importance of France and Germany in the global financial market.

In addition to the above reasons, Taiwan is not a member of the International Monetary Fund and is internationally isolated. Should a financial crisis occur, there is little possibility of foreign aid. Therefore, the government’s awareness of financial independence and financial stability needs to be stronger than other countries. In particular, financial services earn profits by using financial leverage. International capital flows can float a boat or sink a ship. Facing the opportunities and challenges that Hong Kong’s financial industry may bring to Taiwan, we should deal with them pragmatically. Taiwan has adopted a conservative approach to development, seeking progress in stability; now it should further pursue stability in progress, seeking more profitable opportunities, and find the maximum efficiency and balance between financial stability and growth. Do not advocate stability at the cost of everything, for this will lose the opportunities that may be more conducive.

(Paul Chiou, Professor, Department of Finance, Northeastern University, Boston. Peter Chow, Professor, Department of Economics, City University of New York, USA)

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