(This essay was published in Hong Kong Economic Journal on 17 May 2017.)

 

The Chinese Government’s work report in 2017 announced that a plan will be drafted to develop the city cluster of the Guangdong-Hong Kong-Macao Greater Bay Area to give full play to the distinctive strengths of Hong Kong and Macao, and elevate their positions and roles in the country’s economic development and opening up.

 

Previous regional development initiatives under the banner of the Pearl River Delta and the Pan-Pearl River Delta region looked more inward and focused on driving mainland development. The Greater Bay Area initiative, however, stresses external links and securing a commanding position in global industry chains.

 

The new emphasis gives the Greater Bay Area a leading role in China’s economic reform. It aims to build on the region’s geographic location (including time zone advantage in the world), open economic architecture, efficient resource allocation and international communications and logistics networks to support China’s international economic outreach.

 

Avoiding Mistakes of Previous Initiatives

 

The previous initiatives aimed to rationalize economic policies and resource allocations within the region (and with the Mainland) for the benefit of stakeholders in different localities through regional economic integration (and beyond). This proved to be too difficult a task to achieve. In a different context, the Euro area too has demonstrated that the goals of economic integration are too idealistic.

 

The reason why these initiatives faltered is because the key decision players in all regional economic integration and development initiatives are local governments. They are necessarily focused not only on the net gains within their own geographic jurisdictions, but are politically vulnerable to any tradeoffs between local losses and gains that may result from any cooperative bargain.

 

The new Greater Bay Area initiative can learn from these failures to achieve a cooperative policy breakthrough by setting new goals to galvanize external opportunities. Governments would then coordinate policies by playing a supportive role for facilitating and encouraging business initiatives, including those from non-state enterprise ventures. This could provide more all-round incentives for policy cooperation and success.

 

Many observers within Hong Kong and in the Mainland have recognized ‘one-country two-systems’ offers a far more extensive degree of diversity within the region than mere differences in endowments, skills and technologies. It provides a degree of complementary of traits not imaginable in most other regions in the world.

 

The most important advantage Hong Kong offers to enterprises in the region is as a meeting point with the world’s economic networks and as a platform for outreach to the globe’s industry chains. Already Hong Kong is a popular location for Mainland enterprises to set up their regional headquarters to manage their overseas businesses and for international outreach.

 

Over 8,000 Mainland enterprises are now in Hong Kong and they are employing some 12 per cent of the local labor force. Such developments should be pro-actively encouraged in Hong Kong. Barriers to their entry and business expansion should be studied and lowered where desirable, especially for small and medium enterprises in the Greater Bay Area. The reach should go even further so that the region as a whole could play a more effective role throughout China.

 

Aside from Hong Kong’s business friendly environment, hard and soft infrastructure providing world-class communications and logistics services, and English as lingua franca, there are two other critical assets whose potential values have greatly appreciated in the new information and communications technology-driven global economy – its role as an ideas hub and its common law legal system.

 

Information Hub for Global Supply Chains

 

Global economic integration since the 1980s has revolutionized international trade and investment. Today, the notion of American, British, Japanese, and Chinese exports do not really make sense. The concept of national exports is downright incorrect. Almost all goods have components that are sourced from and assembled in diverse locations, and marketed in and shipped to different destinations.

 

What was once called international trade and investment now consists of global supply chains embedded in networks that are continuously reconfiguring. These chains and networks keep reinventing themselves in response to technological change and regulatory change in different jurisdictions.

 

Global supply chains are big, closed systems. Outsourcing happens only when the leading firms who drive these chains decide to invite others into their production networks. The most valuable asset in these chains is knowledge – the knowledge about each outsourced location in the chain and, more importantly, the knowledge at the decision-making nerve center where the leading firm is innovating at the advanced technological frontier.

 

When a geographic location attracts many leading firms to cluster and locate their regional or global headquarters there, it naturally emerges as a vibrant information hub about global supply chains – a place where individuals and firms converge to seek information about opportunities and to learn from each other. Information hubs tend to be self-sustaining because every person or firm seeking information is also an information bearer and enhances the status of the information hub. This is the agglomeration effect of information.

 

Knowledge is a special commodity. It can be reused. Several people can use it at the same time. It causes people to cluster in groups, and tends to grow where groups have already clustered. An information hub for global chains therefore tends to emerge from an existing international economic and financial center. And when this happens it necessarily generates new ideas for new businesses.

 

These global supply chains often appear to be extraordinarily fragile. They are vulnerable to shocks. The least vulnerable members are the nerve centers of those supply chains, but they are not totally immune. But as a consequence of the confluence of global supply chains, an information hub also tends to be fairly immune to shocks that may inflict individual chains.

 

Hong Kong possesses considerable existing advantage in becoming an information hub for a multitude of global supply chains. It already has a substantial cluster of mainland and overseas firms, and connectivity to a vast reservoir of innovative enterprises within the region. It has been a pioneering innovator of numerous global supply chains, and has a considerable concentration of financial and allied professional services and an open cosmopolitan social and cultural environment. It does, however, need to address its chronic shortages of skilled talent and developable land supply.

 

The looming opportunities of a rising Greater Bay Area should spur Hong Kong to ride on the tide of China’s ‘Belt and Road’ initiatives and begin to conceive of a future that is within our experience and that could now be imagined on a much larger canvass.

 

Common Law Legal System

 

As a legal system for business, the common law system is friendlier than the civil law system practiced on the Mainland. Friendliness is defined in two senses. First, providing protection for investors and creditors. Second, facilitating economic innovation.

 

The common law system is less state-dominated than the civil law system and is therefore more conducive to businesses that are innovative. This is because all innovations move into areas that existing legal codes are silent about. This creates delays in getting experimentation and trials approved that would bring innovative ideas to market.

 

But because legal codes are less pervasive and detailed in common law jurisdictions than in civil law ones, common law courts are freer to adjudicate based on rigorous reasoning rooted in legal principles and the doctrine of precedent. As a consequence, they can exercise judgment based on sound legal reasoning, good legal sense, and in accordance with legal principles without being paralyzed. This flexibility, which is not arbitrary, can be critical in facilitating important economic progress at critical junctures in economic development.

 

The advantage of a common law system is particularly apparent in the area of financial innovation, where timeliness is of critical importance. The leading financial centers in the world, especially in international finance, are mostly concentrated in common law jurisdictions. It has been shown that banking and financial market efficiency and competitiveness, labor and product market openness and flexibility, and investor and creditor protection are systematically better developed in common law countries than civil law countries at the same level of economic development.

 

Two important legal cases in the history of Hong Kong testify to how the common law system has facilitated economic development, and illustrate why the common law system of Hong Kong is a unique and invaluable asset in supporting China’s and indeed Asia’s economic development.

 

The first case of Mrs. Lee Pik-fu v. Kwan Cheong [1955] effectively ended the most pernicious effect of the Landlord and Tenant Ordinance enacted in 1947 that had effectively prevented housing redevelopment in the city in the wake of the massive influx of immigrants during the early postwar years.

 

Between 1945 and 1951 the population of Hong Kong increased from 600,000 to 2.3 million. The housing shortage was severe, but old buildings could not be torn down and redeveloped into taller structures that could house more people because of rent control legislation imposed in 1947. Under rent control, tenants could not be evicted to stop landlords from kicking them out after their lease expired in order to raise rents.

 

In 1955, Mrs. Lee Pik-fu applied to the Tenancy Tribunal to evict her tenant Kwan Cheong so she could redevelop her building. At that time the severity of the housing shortage was extreme and the injustice of rent control legislation was increasingly apparent. But the government had no intention of repealing the ordinance whose purpose was to protect existing tenants, and not the landlords or the large number of new immigrants.

 

Mr. John Way who presided at the Tribunal hearings was able to exploit a poor drafting of the ordinance that used the phrase ‘giving up possession’ rather than ‘giving up protection’ to safeguard the interests of the tenant to conclude.

 

Mr. Way reasoned that although Mrs. Lee’s application for reconstruction of the building could not proceed unless the tenant surrendered possession, but it is possible to imagine in some hypothetical situation, the tenant might occupy ‘only a corner of the site to which the proposed redevelopment related so this presence will not materially affect the proposed development.’  This ‘corner’ would have to be either inconceivably small or exceptionally peculiar, but it supported a logical possibility.

 

Such an interpretation allowed the Tribunal to rule that it could allow reconstruction and still imagine that the tenant was not surrendering possession at the same time. It also paved the way for the Ordinance to be amended shortly later to effectively grant the Tenancy Tribunal the power of eminent domain in reconstruction proposals and to determine the appropriate compensation to be made to the tenant for ‘giving up possession’.

 

Without such legal imagination that significantly reduced the transaction costs of evicting tenants, it would not have been possible to redevelop the entire pre-war housing stock into taller structures and supply more new housing units to accommodate the new immigrants. The housing situation would have been far worse. The rigidities of government policy was salvaged by a tribunal judge acting according to common law principles and responding to pressing social demand at a critical juncture in Hong Kong’s history.

 

The second case of Attorney General v. Melhado Investment Ltd. [1983] effectively allowed the use of agricultural land in the New Territories for storage purposes and permitted the miraculous growth of the shipping and freight forwarding industries after the containerization revolution in the 1970s. This enabled the container port to become for many years the busiest one in the world.

 

Prior to the ruling, there had been a great shortage of storage facilities. The demand for vacant agricultural land in the New Territories for parking container boxes grew as re-export and transshipment trade exploded after China’s opening.

 

Block Government Leases that controlled the use of agricultural land in the New Territories had two important covenants.

 

  • The lessee shall not allow nor convert any ground to be demised as agricultural or garden ground into use for building purposes other than for the proper occupation as agricultural or garden ground without [government authorization].

 

  • The lessee shall not erect or construct any building or structure of any description on the said demised premises without first having obtained the approval thereto of the [government].

 

The plaintiff, Melhado Investment Ltd., claimed that the description of the use of the lot as agricultural land was no more than a description of the lot as it existed at the time the Schedule was prepared and did not constitute a restriction of the owner’s rights of use.The government had contended that the lot was restricted to agricultural use under the Block Government Lease while the land in question was being used for the storage of steel girders.

 

The Hong Kong Court of Appeal held that ‘The use of the land as listed in the schedule to the Crown lease was descriptive only. The purpose of the schedule was to identify the lands to which the lease related. If the schedule had been intended to be other than description it would not have been necessary to include in the body of the lease restrictions on building without a license. It would be absurd to construe the lease so as to compel a lessee to maintain a lot as a broken latrine for 75 years.’

 

The effect of the decision was that land described as agricultural under the Block Government Lease was not restricted to that use but could be used for any purpose that did not require a building. This meant that the government could no longer prevent the use of agricultural land (which made up much of the rural land in the NT) for container box storage.

 

Had it not been for the decision of the Court of Appeal, Hong Kong would have been prevented from becoming the busiest container port in the world at a time when demand for port and shipping services was rapidly accelerating because of China’s economic opening. The huge successes of Hutchison Port Holdings and the recently Shenzhen-listed S. F. Express (worth US$25 billion) can be traced back to the permission granted in the Melhado case on the uses of land in the New Territories. The logistics industry in Hong Kong would have suffered enormously without the imaginative reasoning of the court, and so would have China’s opening.

 

Ms. Tong Xiao Ling of China’s Ministry of Foreign Affairs in Hong Kong has written eloquently in the Wall Street Journal (11 May 2017) extolling the territory’s many advantages in contributing to the ‘Belt and Road’ initiatives and its readiness to search for new growth drivers and ways to achieve economic upgrading.

 

It seems to me that as long as government policy can address the shortage of developable land and talent supply in Hong Kong, the path to becoming an information hub for new global supply chains built on the foundations of a common law system that protects investor and creditor rights, and does not stand in the way of business innovation, is bright indeed. This Greater Bay Area initiative will propel the region forward to spearhead China’s ‘Belt and Road” infrastructure investment outreach strategy.

 

Reference

 

Tong Xiaoling, “What ‘Belt and Road’ Means for Hong Kong”, Wall Street Journal, 11 May 2017.

 

 

 

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