Tale of Two Cities

For some 15 years, Hong Kong has been China’s primary venue for financial transactions. That reality has now eclipsed. It was always a temporary convenience rather than everlasting marriage.

In the 1920s, Shanghai was still the major center of international trade and finance in East Asia. The position of the “Pearl of the Orient” eroded only with the turmoil of the 1930s. In contrast, Hong Kong has benefited from global integration since the postwar era. After World War II and the Civil War in China, most foreign firms moved their offices from Shanghai to Hong Kong, which also became the home of Shanghai’s business elite.

As textile and manufacturing grew with low-cost labor and population growth, Hong Kong industrialized. Export-led growth boosted living standards rapidly in the British Crown Colony. Meanwhile, Shanghai was transformed into an industrial center. It became the largest contributor of tax revenue to the central government, but at the cost of crippling its own infrastructure and capital development.

As Shanghai fell into a historical oblivion, Hong Kong thrived, even during the first decade of reforms and opening-up policies because these began in Guangdong. In Shanghai, the development of Pudong was initiated only in 1992. Even after 1997, Hong Kong enjoyed another extraordinary decade as the financial lifeline of the mainland, due to the level of economic development and relatively closed financial sector in China.

A new era dawned only in March 2009, when the State Council approved Shanghai's plans to forge itself into one of the world's leading financial, trade and shipping centers by 2020. In this transition, Shanghai will have the driving role as China’s emerging global financial hub.

In turn, Hong Kong hopes to reinforce its position by exploring a merger with Shenzhen, or by participating in the anticipated regional integration of Guangdong, or by seeking a role in both. Such economic cooperation is challenging, however. It requires the kind of broad political consensus that has been lacking in recent years.

Reset of Investment Flows Among Financial Hubs

Shanghai’s future is already reflected in the shifts of foreign direct investment (FDI) flows among the megacity, Hong Kong and Singapore. In terms of FDI stocks, which illuminate historical trends, Hong Kong has been the most attractive FDI destination in the past three decades in comparison to Singapore, and smaller FDI players, such as Korea, Taiwan, Macao, and the ASEAN nations.

However, today Shanghai is a major destination for FDI, accounting for more than a 10th of China’s total utilized FDI.

The story of FDI flows, which reflect current realities, is very different. There has been a remarkable divergence since 2011 and last year FDI flows in Hong Kong plunged nearly $75billion while FDI flows in Singapore climbed to $57 billion. Since 2005, FDI to Shanghai has almost doubled to $15.2 billion. Last year, FDI flowing into Shanghai was up 21 percent year-on-year.

Here’s the bottom line: last year, FDI flows to Hong Kong fell by more than 20 percent, whereas inflows to Shanghai increased by over 20 percent. Some FDI that used to come to via Hong Kong is moving directly to Shanghai. While Hong Kong is still ranked as the leading global financial hub, it is already closely followed by the challenger - Shanghai.

Unlike Shanghai, Hong Kong and Singapore reaped their free-trade benefits a long time ago. The unwinding of quantitative easing in the West may affect more adversely Hong Kong and Singapore. Finally, China will allow unfettered exchange of its currency in the Shanghai FTZ, which will include free convertibility – which, in turn shall further accelerate FDI in Shanghai.

Shanghai was ready for its future in the 1930s, had it not been for colonialism, Japanese invasion and World War II. During the pre-reform decades, Shanghai also waited for its turn. In the reform era, Shanghai did not yet have the financial capabilities required. Even in the past decade of global integration, the megacity’s financial engine Lujiazui? could only watch as Hong Kong served as the mainland’s financial intermediary.

But now it is Shanghai’s turn.

Dr. Dan Steinbock is the Research Director of International Business at India China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore).