LOS ANGELES- The new Hong Kong National Security Law, passed unanimously by China’s National People’s Congress on May 28, modifies the Hong Kong Basic Law, which was adopted by a previous National People’s Congress in April of 1990. This change may have profound effects on the economic relations between the United States and China. In this essay, we focus only on the economic aspects while acknowledging that the longer-run geopolitical aspects may be much more important than the short-run economic consequences discussed here.
While the U.S. points to the National Security Law as a violation of the Sino-British Joint Declaration that Hong Kong would act as if it were a separate economic and political entity until at least 2047, China points to civil unrest in Hong Kong. Hong Kong Chief Executive Carrie Lam stated that the new law was to “safeguard national security,” and as such, it is a necessary step. Moreover, China points to civil unrest in the U.S. and the Trump Administration’s statements with regards to it as being one-and-the-same. Although we don’t know how all of this will play out, it seems likely that the new security law will be implemented, and as likely that the U.S. will respond with restrictions and sanctions on China. If we suppose the highest level of economic escalation, that of the loss of the Hong Kong Special Administrative Region (HKSAR) designation for Hong Kong by the U.S., a loss of designation foretold by the report from Secretary of State Pompeo to the U.S. Congress on May 27, what might be the economic consequences?
There are two aspects of the Hong Kong economy that relate to U.S./China economic relations. The first is the trade between Hong Kong and the U.S. This is trade that is not subject to the tariffs imposed by the U.S. on Chinese goods. A loss of status means that Hong Kong exports to the U.S. would be subject to these tariffs. In 2019, the total amount of imports into the U.S. from Hong Kong was $16 billion which amounts to 0.5% of U.S. imports from the rest of the world and 2.8% of total Hong Kong exports. It is not at all clear that the U.K. and the E.U. would also remove Hong Kong’s Special Administrative Region status in response to the National Security Law, and therefore we will assume this is not relevant here. About half the exports are goods that do not have Section 301 tariffs against them. Thus, even though the tariffs would likely mean higher prices for U.S. consumers, there is not likely to be a significant reduction in Hong Kong exports. However, Hong Kong is a country with a trade deficit (-$29 billion) with the U.S. and that is potentially at risk with the end of HKSAR.
The second, more important aspect of Hong Kong for U.S. China economic relations is Hong Kong as a financial center. U.S. companies use Hong Kong as a base of operations for foreign direct investment in China. Of the total FDI in China, 72.1% comes from companies based in Hong Kong. Of course, not all of this, perhaps not even the majority, is from the U.S. Nevertheless, if Hong Kong is no longer believed by potential investors to be a city-state with an independent reliable judiciary to enforce the property rights of foreign companies investing in China, even if this is ultimately not the case, there will be a move of those firms away from Hong Kong. The alternatives are Taipei, Singapore, Tokyo, and Seoul. Each of these present increased costs relative to Hong Kong. These increased costs imply less FDI into China from the U.S.
Is China willing to accept this outcome? The evidence thus far is in the affirmative. Thus, the implication of the imposition of the National Security Law is quite simply a further decoupling of the two economies. U.S. firms lose profit opportunities and Chinese firms lose a source of investment capital. For the U.S. investor, marginal investments in China would no longer be profitable, and the level of cross-border financial activity would diminish. A declining financial sector in Hong Kong would move China further away from the RMB being accepted as an international currency because, for a large part of the world economy, there would no longer be a quasi-China financial center with the legal structure to support it. While we have not analyzed the implications with respect to the Hong Kong dollar nor the Hong Kong economy per se, the obvious implication is for a weaker HK$ and for slower if not negative economic growth.
In short, the loss of HKSAR status with the United States would result in less economic activity in both countries, the loss of Hong Kong as a trans-shipment port for China, the derailment of the RMB as a potential world currency, and an increase in the U.S. balance of trade deficit. While the analysis in this communication is based on speculation about future political actions, the risks are not. To be sure, until those political events unfold, events that might in fact lead to more cooperation and a modification of the law, or the implementation thereof, that would satisfy Washington, expect a defensive move on the part of firms in finance and trade outlined here.
About the report
Cathay Bank has established a sponsorship relationship with UCLA Anderson Forecast to produce a U.S.-China Economic Report. In this report, UCLA Anderson Forecast will talk about their view of economic analysis and perspective on the current and future outlook relating to the two largest economies in the world – the United States and China.
UCLA Anderson Forecast has been the leading independent economic forecast of both the U.S. and California economies for over 65 years. The annual report and quarterly columns written by UCLA Anderson Forecast will focus on current topics affecting investment flows and associated economic events between China and the United States.
This report includes forecasts, projections and other predictive statements that represent UCLA Anderson Forecast’s economic analysis and perspective on the current state and future outlook of the economies of The United States and China in light of currently available information. These forecasts are based on industry trends and other factors, and they involve risks, variables and uncertainties. This information is given in summary form and does not purport to be complete. Information in this report should not be considered as advice or a recommendation to you or your business in relation to taking a particular course of action and does not take into account your particular business objectives, financial situation or needs.
Readers are cautioned not to place undue reliance on the forward-looking statements in this report. UCLA Anderson Forecast does not undertake any obligation to publicly release the result of any revisions to these forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date of this report. While due care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside UCLA Anderson Forecast’s control.
About the authors
Jerry Nickelsburg, Director, UCLA Anderson Forecast
Jerry Nickelsburg joined the UCLA’s Anderson School of Management and The Anderson Forecast in 2006. Since 2017 he has been the Director of The Anderson Forecast. He teaches economics in the MBA program with a focus on Business Forecasting and on Asian economies. He has a Ph.D. in economics from the University of Minnesota and studied at The Virginia Military Institute and George Washington University. He is widely published and cited on issues related to economics and public policy.
William Yu, Economist, UCLA Anderson Forecast
William Yu joined the UCLA Anderson Forecast in 2011 as an economist. At Forecast he focuses on the economic modeling, forecasting and Los Angeles economy. He also conducts research and forecast on China’s economy, and its relationship with the US economy. His research interests include a wide range of economic and financial issues, such as time series econometrics, data analytics, stock, bond, real estate, and commodity price dynamics, human capital, and innovation.