Restructuring of the Hong Kong Economy

9.        In common with other places in Southeast Asia, Hong Kong experienced a bubble economy in the years up to and including 1997.  This was the result of various factors, including the restriction on land supply and the effect of negative real interest rates brought about, against the background of the linked-exchange-rate system, by low interest rates in the US and a high inflation rate in Hong Kong.  Following the outbreak of the Asian financial crisis, this bubble burst.

10.     Meanwhile, globalisation is leading to closer economic ties throughout the world. Increasing trade flows magnify comparative advantages among different areas and accelerate international division of labour.  For Hong Kong, globalisation in general, and integration with the Mainland economy in particular, have thrown down the gauntlet of economic restructuring.

11.     Since the opening up of the Mainland in the 1980s, Hong Kong enterprises, leveraging the low costs there, have expanded their scale of production and enhanced their competitiveness.  Our domestic economy has upgraded itself in tandem.  Support services for Hong Kong and the Mainland replaced manufacturing industries as the fastest-growing sector.  The South China region has now evolved into one of the world's most important production bases.  Since the mid-1990s, service industries on the Mainland have also been developing apace.  During this period, the bubble economy emerged in Hong Kong, giving rise to high operating costs here.  Some Hong Kong service industries started to move northwards as well.  Moreover, after reunification, Hong Kong residents, in increasing numbers, travel across the boundary to spend, affecting Hong Kong's domestic consumption.

12.     In the process of economic integration, the price differential between Hong Kong and the Mainland will inevitably narrow gradually.  In economics, this is called "factor price equalisation".  The price of tradable products adjusts swiftly due to relatively free trade between the two places.  The adjustment of non-tradable factors such as land and labour is slower. "Factor price equalisation”, however, does not mean that price levels between Hong Kong and the Mainland will be exactly the same, just as New York, London and Tokyo have relatively higher prices than their neighbouring areas.  We can foresee that prices in Hong Kong will generally remain higher than those in the Mainland.  The magnitude of this price differential will hinge largely on our ability to provide high-value services and goods.

13.     As the bursting of the bubble economy coincided with economic restructuring, Hong Kong has experienced heavy deflationary pressure.  Property prices have dropped from their peak by more than half.  Labour costs are being trimmed through pay reductions and layoffs.

14.    In the face of persistent deflation, there are some who have suggested abolition of the linked-exchange-rate system.  I must reiterate that the Government has no intention of making any change.