China's official statistics are well known to be woeful...John Ganaut reports on how the wealthy (unsurprisingly) hide much of their income and wealth:

PROFESSOR Wang Xiaolu sparked an online uproar two months ago by publishing the results of his "grey economy" study in China's leading business magazine, Caijing.

His survey showed the top 10 per cent of earners were successfully hiding about two-thirds of their income from the National Bureau of Statistics, meaning official estimates of income inequality, gross domestic product and tax evasion are all woefully understated.

That senior government officials studied his work, rather than bury it, shows how the realm of economic policy has been largely protected from the heavy hand of government censorship.

It probably helps that Wang's National Economic Research Institute is not beholden to its benefactors. "We receive no money from the Government, so I am free to say what I like," Wang says.

Now the economics professor is set to do it all again. This time, instead of identifying the state as the agent of necessary reform, he sees it as the object of reform.

He believes the glaring contradiction between China's lean, free-market capitalism and its inflating, closed and corruptable government is about to become the country's central economic challenge.

Wang's economics training was practical, if not conventional. His formal education ended in 1966 when Beijing was up-ended by the euphoric madness of Mao Zedong's cultural revolution. When he should have been finishing Year 8, he was went to farm corn and sorghum at a village called Xiaoxiangzhai in a poor crevice of Shanxi province, in China's mid-west.

When he should have been at university, Wang worked at a Shanxi bauxite mine, then an aluminium smelter and an electronic motor factory in Beijing.

He says he was happy enough learning about economics in his country exile by reading Karl Marx, Friedrich Engels and some contraband works of Nobel laureate Paul Samuelson.

As a peasant, Wang wasn't as useless by the time he left as when he arrived, he says, but Mao could probably have put his talents to better use.

In his new paper, jointly written with Professor Fan Gang, a People's Bank of China monetary policy committee member, and PhD candidate Liu Peng, Wang calculates that Chinese productivity rose by just 0.74 per cent a year under Mao.

In 1976 Mao died, as did the Cultural Revolution. Deng Xiaoping soon won control of the Communist Party and Wang was invited into the new Chinese Academy of Social Sciences. He had never studied in senior high school, but neither had most other job applicants his age.

Wang argues that the Chinese economy has been propelled by three distinct surges of productivity, each triggered by institutional reforms that freed resources to be allocated to more efficient uses.

In the first, soon after Deng's rise, peasants were unshackled from their communes. They moved out of agriculture and earned money from whatever they produced. China's productivity growth quadrupled to 2.9 per cent in the 1980s and GDP growth rose from 6 to 10 per cent.

Second, in the late 1980s, as Wang was applying to become an academic at the Australian National University without ever having attended an undergraduate class, peasants were freed to find higher valued work in the city.

The urbanisation phenomenon, which is still continuing, pushed productivity growth to about 4.4 per cent in the 1990s.

Third, the rise of a new entrepreneurial class has diverted resources from China's hapless state-owned sector. Workers were freed to jump from wasteful government entities to more efficient private ones.

In a separate marketisation survey, Wang shows the private market economy (which excludes state-controlled listed companies) now accounts for 69.2 per cent of China's economic output, up from 22.4 per cent in 1978. Privatisation helped to sustain productivity growth at about 3.6 per cent between 1999 and 2005.

China is getting richer largely because the Government has got out of the way and allowed resources to be allocated more efficiently. But now the early agricultural reforms are complete, there is not much left to be privatised and urbanisation is becoming proportionately less important.

Wang argues that the Government needs to remove itself from part of the economy for a fourth time if China is to sustain its phenomenal growth rate.

"The first thing we need is transparency to stop corruption and increase efficiency," Wang says.

His report shows the Government bureaucracy is getting much bigger, even as the services it delivers are shrinking.

Certainly, a glance at recent Chinese media would suggest that corruption and its associated inefficiencies have never been a bigger problem.

Local officials are covering up a child-slave trade in Shanxi; a former Shanghai party boss is about to be prosecuted for "huge" embezzlements; the former head of Sinopec, Asia's largest oil refiner, has been detained for questioning.

And it goes on.

While some of China's intellectuals are lamenting the squandered opportunities for political reform since 1989, some of its leading economists believe the state still has a choice.

It can make its workings transparent and accountable to the people it is meant to serve, or it can lead the country back to the miserable productivity and GDP growth rates that China has not known since the rise of Deng Xiaoping.

Cash that's worth morth than face value?The classic cash box trap:

On their second day of trading, units of the HSBC China Dragon Fund (0820) soared 41.5 percent on heavy turnover, driven by the irrational exuberance of foreign funds and asset managers toward the A-share market, analysts said.

Both institutional investors and retail punters, bullish on the prospects of an actively managed China fund - despite the fact that it has yet to put any money into the frenzied A-share market - snapped up the units...

"This is totally crazy. It is irrational exuberance," said Fulbright Securities general manager Francis Lun Sheung- nim. "The fund has not even started to do any investing, and [the units] are skyrocketing like magic. All they have now is just cash. It is irrational." Lun expects the unit price of the fund to correct in the near future.

This is doing the rounds, from a PR firm promoting SCMP.com:

Bush's source for China revealed

via ESWN

And to the nice man who sent me an email offering 3 months free SCMP.com access, my point remains the same: if you hide your content behind a paywall, it's not going to get linked by me.

The pork blight is hitting hard...but I wouldn't be racing to CUKH for an economics degree any time soon:

Economist Fred Kwan Yum-keung, an associate professor of economics and finance at the City University of Hong Kong, said higher pork prices will not generate inflation. He explained that inflation is reflected in the Consumer Price Index which is based on a basket of commodities.

Because pork is only one of the many commodities involved, a surge in pork prices will not cause the index to rise.

Ever wonder why men in Hong Kong are smiling so much? The Census people might have the answer:

Hong Kong's population will reach 8.57 million in 30 years' time, when up to one in four people will be aged over 65 and the gender imbalance will get worse, according to projections by the Census and Statistics Department.

The department predicts the number of males will fall from last year's 912 per 1,000 females to 709 per 1,000 females by 2036.

It's the 86th birthday of the CCP...and things have changed a bit since they started running around the countryside killing landlords and promising revolution. Up in Gansu province, the municipal authorities have tried an old-fashioned way of dealing with inflation:

As the debate boils over rising prices of the favorite bowl of beef noodles in Lanzhou in Gansu province, municipal authorities insisted a price cap will stay.

But price controls announced June 26 that in "an ordinary grade restaurant," a large bowl of beef noodles cannot be sold for more than 2.5 yuan (HK$2.58), and no more than 2.3 yuan for a small bowl, has given rise to arguments on how far the government should interfere in commercial decisions...

The pricing move is not seen in a good light by top policy planners. The National Development and Reform Commission said Lanzhou's move is not in keeping with the "rules of the market economy."

A scholar at the Chinese Academy of Social Sciences remarked that the intervention was a "return to a planned economy."

Donald Tsang is a man of his word...he promises to find some road to full democracy for Hong Kong and then offers up a brilliant way to achieve it: a green paper so full of choices that it's the very model of democracy itself. With 7 million combinations, one for each Hong Konger, it is actually possible for every citizen of this city to choose their own democratic model using Donald's ever-so-easy mix-n-match democracy chooser. You can choose who, you can choose how, you can choose when....so stop complaining already.

The tabloid press in Hong Kong can be amongst the most vicious in the world...and being a small town, you never know when you're going to get caught. That's the moral of the saga of RTHK head Chu Pui-hing, who's quit after being caught by a group of paparazzi who spotted him with a young lady leaving a club. He didn't do himself any favours by ducking for cover and running away and when the media smell blood they don't let up until they get their catch. We now know all about Coco from Szechuan, his young companion, and that his wife has forgiven him (at least until the fuss has died down). Coco's career is looking up.

But what this all exposes, besides inept PR from the man that is running the city's public broadcaster, is the double standards by which Hong Kong lives. The city, like many others, has numerous hostess bars, nightclubs and the like. They are frequented by many. So what does it matter if the head of RTHK goes to a club and walks out with a woman? How is this relevant to his job? His organisation? The rule is that people in authority must be held to some higher standard, but why? Is RTHK any better or worse his activities after hours? If he hasn't done something illegal, what is the case for his leaving his post (other than that RTHK is at an all time low already and could only get worse after this)? In short, what has Mr Chu actually done wrong here?

The question of compensation of lawyers is, if you believe lawyers themselves, a difficult one to deal with. Any hint of a "no win, no pay" system and you'll get cries and protests from the best of them. For example, in today's SCMP:

Lawyers yesterday expressed concern that they would bear the highest financial risks under the conditional legal aid fund proposed by the Law Reform Commission.

Michael Vidler, a solicitor who has handled many legal aid cases, said the "no win, no fee" principle adopted in the proposal was unfair to lawyers. "It's a bit like going along to a doctor and say, `if I get better I will pay you, if I don't get better I won't pay you'," he said.

There has been much hoopala and carrying on over yesterday's largely meaningless 10th anniversary of Hong Kong's unification with the motherland. A couple of things stand out. First there were numerous references to Hong Kong's "re-unification"...now students of history can argue many things, but Hong Kong was basically a small fishing village prior to the British taking it over. One could possibly argue the New Territories were always Chinese territory that was under lease, so that part couldn't be "re-unified" as it was already part of China. As for the rest of the city, how do you reunite when the place didn't previously exist?

But that's a minor quibble. A far larger one revolves around President Hu Jintao's statement yesterday:

"One country is the prerequisite of two systems. Without one country, there will be no two systems," Mr Hu said. "One country and two systems cannot be separated from each other. Still less should they be set against each other."

Mr Hu described the "one country, two systems" concept, and its successful implementation, as China's unique contribution to mankind's political development.

The Economist has a survey of the Big Lychee which basically says that for the most part China's surprised everyone by not screwing Hong Kong up too badly...partly because Tung Che-wa did a great job of it on his own. The survey conclusion is simple: the place is booming but it can't continue forever as an economic experiment without also allowing it to be a political experiment in real democracy. China has a real chance to use Hong Kong as a willing guinea pig for political reform, safely away from the Motherland. But to date Beijing and its toadies in this city have constantly run from the challenge. The politics of this city is dysfunctional, revolving largely around pro-democracy or pro-Beijing camps while the bureacracy runs the city as it likes. The contradictions between the politics and economics of Hong Kong are sowing the seeds for eventual chaos.

Update: Blogger and Hemlock friend Daisann McLane writes about the handover anniversary in Slate. And over at ESWN, a translation of an article about the Hong Kong you may not know about...if you're a mainlander.

The Economist articles are all reproduced under the jump.

One country, no democracy

If only Hong Kong were allowed to show China the way politically as it has economically

WHEN China took back sovereignty over Hong Kong ten years ago, it promised to preserve its unique “way of life”. The imaginative formula for doing this had two parts. The first was “one country, two systems”—ie, Hong Kong would still be capitalist, while China would pretend, ever less convincingly, to be socialist. The other was “Hong Kong people ruling Hong Kong”. As China's leaders descend on Hong Kong this weekend for tenth-anniversary fireworks and self-congratulation, the place is booming and has changed far less in ten years than has almost any other city in China (see our special report). Its capitalist system is largely intact. But on its commitment to let Hong Kong people run Hong Kong, China has flouted its promise of autonomy in everything apart from foreign affairs and defence. This is a potential disaster for Hong Kong, and a missed opportunity for China.

China has ensured that elections to Hong Kong's legislature, and those for the “chief executive”—the successor to Britain's colonial governors—are elaborately rigged in favour of “pro-China” candidates. Pointing to Hong Kong's success as an undemocratic British colony, and its continued success as a slightly less undemocratic “special administrative region” of China, the Communist Party can argue that this shows it was right to deny Hong Kong full democracy. That is nonsense.

It is true that, to its shame, Britain never bestowed democracy on Hong Kong. But it did endow it with strong institutions such as an independent judiciary and a free press. They are crucial to Hong Kong's standing as a truly global city. They have survived the past ten years better than many feared. But both have suffered some erosion. Worse is to come unless Hong Kong has a government with the legitimacy to defend them. And that requires a proper democratic mandate.

Curiously, many of those businessmen in Hong Kong who used to argue that full democracy would serve only to destabilise the place and make China cross have become converts to democracy, despite the flourishing economy. They realise that the present constitutional muddle simply does not work: the lack of democratic legitimacy leads to a constant search for an elusive consensus and indecisive government.

The Hong Kong model
There is another reason why democracy in Hong Kong should be welcomed by the government in Beijing: Hong Kong could serve as a laboratory for political change on the mainland, as it earlier served as an economic model.

A crucial element of the reforms unleashed in China by Deng Xiaoping nearly 30 years ago was the recognition that Hong Kong had much to offer China. He saw how much its entrepreneurial people and their capital could do for the mainland; and he copied some of its economic freedoms. Often judged the world's freest economy, Hong Kong is not a bad model. The Pearl River Delta—Hong Kong's hinterland—became China's fastest-growing region.

Hong Kong could now play a similar role in politics, where the Communist Party is again toying with the idea of reform (see article). China remains a viciously repressive dictatorship, where any weakness of the central government is compensated by the even more arbitrary exercise of power by local authorities. But people are immeasurably freer now than they were 30 years ago.

Every year sees tens of thousands of protests—many by peasants over official land grabs. But the new property-owning, shareholding middle classes are also restive. None of this, so far, amounts to a challenge to Communist Party rule. But it does suggest that the instability the party fears may come. Hong Kong would be a good place to try an alternative way of dealing with dissent. On Sunday, after the fireworks have fizzled and China's and Hong Kong's leaders have told each other how well they are doing, tens of thousands of Hong Kongers will take to the streets to demand their democratic rights. It is fair to predict that they will do so without violence and with considerable good humour. They should be cheered on by everybody who wishes China well.

The resilience of freedom

After ten years of Chinese sovereignty, Hong Kong's economy is thriving. But politics, says Simon Long (interviewed here), remains a one-horse race AFP THE torrential rain that fell on Britain's end-of-empire parade on the night of June 30th 1997 conjured up apocalyptic visions of the future of Hong Kong. Prince Charles bequeathed a sodden city to Jiang Zemin, China's president, and left on board his yacht with Chris (now Lord) Patten, the last British governor. That very night the city's new masters swore in a new “provisional” legislature appointed to replace one elected under British rule. Television cameramen flocked to the territory's borders with China to film the arrival of the People's Liberation Army. It proved to be almost the last chance to see those soldiers in Hong Kong: they disappeared into their barracks. There were no round-ups of degenerates, dissidents or democrats, and no newspaper closures.

It is tempting to argue that Hong Kong has changed China more than the other way round, as this newspaper and others forecast in 1997. Certainly China has changed the more, though Hong Kong's role in this—compared with, for example, the dynamic momentum of China's internal reforms, and the country's accession to the World Trade Organisation—is debatable. Yet as Hong Kong and China celebrate the tenth anniversary of their reunion, their self-congratulation seems justified. An experiment without historic precedent, the transfer of Hong Kong's sovereignty while keeping its unique way of life, has come off—so far.

What has not changed in the “Hong Kong Special Administrative Region” (SAR) of China is more obvious than what has. The city streets still hum to the rhythm of commerce. The skyline remains one of the glories of urban ambition. Even the grumbles are unchanged. The harbour—the reason this “barren rock” became a metropolis—continues to shrink as Hong Kong island reverts to the mainland through reclamation.

The red flag of China flutters over Government House, Lord Patten's former home, and government offices are adorned with China's state insignia. But the street names still celebrate former colonial governors—Des Voeux, Robinson, Nathan, Bonham (though, for the foreseeable future, a Patten Boulevard seems unlikely). And servants of the colonial regime still play important roles under the new dispensation. Donald Tsang, Hong Kong's chief executive, the successor to the governor, was formerly a senior member of Lord Patten's administration.

Drastic changes, however, were never likely. The 1997 handover was part of a process rather than a life-changing event. The largest part of Hong Kong's land area, the New Territories, had been Britain's under a 99-year lease granted in 1898. China never recognised that agreement, nor indeed the treaties ceding Hong Kong island and Kowloon in perpetuity. But the expiry of the lease presented practical difficulties, such as over land tenure, so China agreed to negotiations with Britain that led to the two countries' 1984 “Joint Declaration”, confirming Hong Kong's reversion to China at the end of the lease.

Unusually, then, the change of sovereignty was preceded by a long planning period. Unprecedentedly, China also agreed that the transfer would happen on the basis of “one country, two systems”. Until 2047 Hong Kong would keep its own economic and political system and enjoy autonomy in everything except foreign affairs, defence and national security. This was an extraordinary concession for a proud, resurgent nation. It reflected the vision of Deng Xiaoping, who was in the process of opening China up from the autarkic blind alley of Mao Zedong's Cultural Revolution. No Chinese leader since has enjoyed the popularity of Deng in those early years. Many in Hong Kong say that the anniversary the island should be celebrating is not this year's but the one coming up in December next year: the 30th anniversary of the Communist Party plenum that marked the Deng restoration.

Even so, there were reasonable doubts about whether “one country, two systems” could work. The whole point of Hong Kong, both for the people living there and the foreigners doing business with it, was that it was not quite China. It was a place of refugees, “a Chinese colony that happen[ed] to be run by Britain”, according to its historian, Frank Welsh. By 1997 it had become a prosperous, service-oriented economy and a sophisticated, cosmopolitan society. China was a poor agricultural nation in the throes of the world's fastest industrial revolution.

Hong Kong had been a colony with only limited self-rule. But Lord Patten and others like to point to the observation of the late Samuel Finer, a famous historian of government, that Hong Kong's was a unique political system: undemocratic but free. China was, and remains, undemocratic and unfree. Optimism in the late 1980s that its opening-up might include political liberalisation was crushed by the Tiananmen Square massacre in Beijing on June 3rd-4th 1989. For a generation in Hong Kong, that was a defining moment. But 18 years have passed, and for today's bright, otherwise well-informed and sophisticated 17-year-olds mention of it rings only distant bells.

That is not surprising. The biggest challenges Hong Kong has faced in those 17-year-olds' lifetime have stemmed not from Chinese repression but from Asia's 1997 financial crisis, the bursting of the dotcom bubble, and epidemics of bird flu and severe acute respiratory syndrome (SARS). Hong Kong weathered those storms. The economy has just enjoyed its best three years for two decades. As open and free as any in the world, it has proved its flexibility and resilience.

This report will argue that, with some important lapses, China has kept its promises, and “one country, two systems” is working better than many expected. But its continued success is jeopardised by the failure to tackle the big unresolved issue left at the handover: the establishment of an accountable government checked and balanced by a representative legislature. Hong Kong will never sit comfortably in China as long as its politics is a battle between two camps, one labelled “pro-Beijing” and the other “pro-democracy”.

To the relief of Britain and China, Hong Kong has been largely absent from world headlines in the past turbulent decade. But it has not been without its drama. Besides the unforeseen financial and health crises, there was, in effect, a mass uprising four years ago, in protest at an “anti-subversion law” that China wanted Hong Kong's government to introduce. Seeing their civil liberties threatened, Hong Kong's people took to the streets and won a deferral of the law. Their political freedoms, too, are proving resilient.

Democracy deferred

Ten years on, the same old arguments and the same old excuses are trotted out

THERE are countless ways to rig an election, some crude, some more sophisticated. But seldom in the history of electoral democracy has so much brainpower been devoted to ensuring that a poll is a foregone conclusion as in Hong Kong over the past three decades. The result is that the people of Hong Kong still do not directly elect by a simple majority either their legislature or the top official in the executive branch, the chief executive.

EyePress News

Tsang and Leong: not similar enoughDonald Tsang, the present incumbent, was “re-elected” in March by an “election committee” of just under 800 people, chosen according to Byzantine rules designed to make certain that the candidate supported by the Chinese government in Beijing will win. Unexpectedly, an opposition candidate, Alan Leong of the Civic Party, secured the necessary nominations from more than 100 committee members to stand against Mr Tsang. So the election was watched with interest, but not suspense: Mr Tsang's victory was never in doubt.

In fact he would have won a fair election. Opinion polls show him enjoying approval ratings of 70% or more. Mr Tsang (or Sir Donald, as he prefers not to be known these days) compares favourably with his predecessor, the SAR's first chief executive, Tung Chee-hwa. Mr Tung had to cope with a series of unforeseen disasters. Even so, his leadership was in most estimations disastrous. China forced him out in 2005 and picked Mr Tsang as his successor.

Mr Tung was a shipping tycoon from a Shanghai family who owed his business's survival to the government in Beijing. Mr Tsang has worked his way up from fairly humble origins and is seen as a local boy made good and a competent administrator. Critics accuse him of being a chameleon. He still sports the bow-ties he wore as a colonial civil servant, but has recently been seen in a Chinese-collared jacket.

Yet Mr Tsang himself has said that the debate about electoral democracy “tortures” Hong Kong. This seems an exaggeration. When, as now, the economy is thriving, the place hardly seems preoccupied with its democratic deficit. But Mr Tsang is right that naturally this is a burning concern for everybody who cares about politics. Increasingly, it also bothers those who want strong executive-led government.

Mr Tsang has promised to resolve the problem during his present term of office, which ends in 2012. According to polls by the Hong Kong Transition Project at the Baptist University, 86% of Hong Kong's people saw him engage in televised debates with Mr Leong and 69% heard him make this promise. That makes it another important reason for his popularity. A government green paper is to be produced later this year, listing three routes to the “ultimate aim” promised in the Basic Law—the mini-constitution for Hong Kong promulgated in 1990—of “universal suffrage” for both Legislative Council (LegCo) and chief-executive elections.

The sooner the argument is settled in favour of representative democracy the better. Since political-party platforms are still defined around when and how “universal suffrage” is to be achieved, the constitutional debate distorts and stunts the development of normal, policy-based political competition. Since LegCo is a mixture of popularly elected delegates and representatives of “functional constituencies” (professional, commercial and other interest groups), its powers—already weak—are attenuated further by questions over its legitimacy. And since Mr Tsang's own popular mandate is even more tenuous, the system is biased towards inaction.

The lack of democracy seems incomprehensible. On the World Bank's figures, Hong Kong in 2005 was the world's tenth-richest country by gross national income per person at purchasing-power parity. One study published this year suggests that its people have the world's highest average net worth (more than $200,000 per person). It is cosmopolitan, modern and open. Its people have proved themselves orderly, moderate and pragmatic—as in their support for Mr Tsang, Beijing's man. They have at times taken to the streets in their hundreds of thousands, but they have done so without violence.

When China agreed in the early 1980s to negotiate with Britain to resume “the exercise of sovereignty” over Hong Kong, its starting-point was that the territory should be handed over intact. Officials sometimes used the analogy of a fragile ornament—“a Ming vase”. A better simile might have been an intricate piece of machinery whose workings no one fully understood. At the time, Hong Kong's administrative and economic system had little in common with the newly reforming one-party rule of Communist China, but it worked well. By then Hong Kong had spent some 140 years as a British colony without enjoying the right to choose its own leaders.

So agitation in Hong Kong for Britain to allow a democratic system was greeted with suspicion. Yet Hong Kong's leaders and legislators had to be chosen somehow, and China stated in the Joint Declaration that the chief executive would be appointed by the central government after elections or consultations held locally. LegCo would “be constituted by elections”. The complex system that was devised allowed some direct elections and some indirect ones, via a carefully selected “election committee” (the mechanism also used to choose the chief executive), and some “functional constituencies”, the majority of which would do what China told them. Those elected to LegCo in 1995, under British rule, were meant to be on a “through train” to Chinese sovereignty.

After the Beijing massacre in 1989 a stronger democratic mandate for future Hong Kong governments seemed even more important. The last British governor, then plain Mr Patten, a Conservative politician rather than, as usual, a senior diplomat, seemed to agree. He tried to squeeze the demands for more representative democracy into the restrictive framework he had inherited.

China cried foul, alleging a serious breach of the spirit of the Joint Declaration. But the election went ahead in 1995, and “pro-democracy” candidates trounced the “pro-Beijing” camp. The through train, however, was derailed. Fresh elections under China's rules were held in 1998, and changes in the composition of LegCo resumed “the gradual and orderly progress” promised in the Basic Law. The number of directly elected members rose from 20 in 1998 to 30 in 2004, whereas those picked by the election committee went from ten to nothing. The functional constitutencies remained at 30.

A problem left over from history
In the September 2004 elections “pro-democrats” as usual won about 60% of the votes, despite concerted opposition co-ordinated by mainland-affiliated groups in Hong Kong. This gave them just 25 of the 60 seats. China's “parliament”, the National People's Congress (NPC), the ultimate arbiter of the Basic Law, had already ruled in April 2004 that the time was not right for “universal suffrage” in the LegCo elections in 2008, nor for the chief-executive elections in 2007. The “ultimate aim” is receding into the distant future.

Donald Tsang may be popular, but not nearly as popular as competitive politics. For those seats on the committee to re-elect him where individual voting was allowed in December 2006, pro-democrats triumphed: 114 of 137 candidates who favoured a contested election got in.

Even Jasper Tsang, of the Democratic Alliance for the Betterment and Progress of Hong Kong (DAB), the biggest single party in LegCo, would welcome universal suffrage. The DAB, which developed from the clandestine local communist party of colonial days, is the main grassroots “pro-Beijing” party. Yet Mr Tsang argues real elections could free the DAB of an association that puts off many voters, and allow it to exploit its formidable local network and strength on bread-and-butter issues.

Even if most of Mr Tsang's colleagues agreed with him, which they do not, the DAB would be constrained by what he calls its “20-80” problem. The party's core supporters, he says, are among the 20% of the population who toe the Beijing line, and would be alienated by any attempt to stray from it. But a cautious proposal for minor electoral reforms ahead of this year's green paper would not win over many of the other 80%.

Much of the time the DAB finds itself in a de facto alliance with another “pro-government” party, the Liberals, dominated by businessmen. Its chairman, James Tien, agrees with Mr Tsang that universal suffrage is unlikely to arrive in 2012. Unlike Mr Tsang, however, he does not think it desirable, regarding it as “too major a change”. The Liberals' biggest proposed reform for 2012 is to give everybody a vote in the chief-executive elections, but to raise the number of nominations a candidate needs to run; this hurdle would then be lowered in 2017 and removed in 2022. As Mr Tien engagingly suggests, voters “could choose between Donald Tsang A, Donald Tsang B and Donald Tsang C”. Others also see the election committee as a useful mechanism for restricting the choice to candidates Beijing supports.

The “pro-democrat” camp is also diverse and divided. Its leading lights range from free-market liberals to left-wing labour activists to the former head of the civil service under Lord Patten and Tung Chee-hwa, Anson Chan. Mrs Chan (“the best civil servant I have ever worked with, by a street”, says Lord Patten) would have made an excellent chief executive. China may have rejected her as somehow tainted by her experience under British rule, and may feel vindicated by her conversion to an explicitly pro-democracy stance. But that conversion has added to her already considerable popularity.

The biggest pro-democracy party, the Democrats, has seen its dominance eroded since the handover. Some of its younger leading lights joined more radical groups. The Civic Party, formed in 2006, has attracted some support, notably from middle-class professionals. Some of the democracy movement's longest-serving leaders have become wearily pessimistic. Martin Lee, founder and former chairman of the Democrats, compares this year's green-paper exercise to an earlier one, in 1987. This was a shameful episode in Britain's late colonial history. Designed to quell enthusiasm for brisker democratisation, it failed to admit the reason: that China would not allow it. Instead it buried the demand for direct elections to LegCo—as the fifth sub-option of the fourth main option in chapter four. “Twenty years completely wasted,” concludes Mr Lee.

Well, not quite. Hong Kong has acquired a more vigorous and vigilant legislature. But Mr Lee recalls that ten years ago nobody was arguing that 2007—the earliest date for the introduction of full democracy allowed under the Basic Law—was too early. Now few expect it even in 2012.

Under the Basic Law, LegCo electoral arrangements after 2007 are for Hong Kong to decide alone, to be notified to Beijing “for the record”. Yet they may be harder to reform than those for the chief-executive elections, which require the NPC's “approval”. The functional constituencies that occupy half of LegCo at present have become powerful vested interests, unlikely to vote themselves out of existence. Already there is talk of their becoming a second chamber to a popularly elected LegCo. Mr Tien, directly elected himself, says the system works better than the sort where legislatures are full of directly elected generalists who become easy prey to professional lobbyists. “We have the lobbyists in parliament,” he explains.

AFP

The people's flag is deepest redThe delay in introducing full democracy is damaging, for several reasons beyond the affront to natural justice. A representative government in Hong Kong would be the best monitor and guarantor of continued autonomy. And, as Mr Lee puts it, the future of the rule of law in the long run depends on popular control of the legislature. But there is also a growing feeling that the present arrangements simply do not work. The lack of a constitutional link between the legislature on the one hand and the chief executive, his advisory “executive council” (ExCo) and the civil service on the other inhibits both policymaking and implementation. Critics point to the government's inability to reach consensus on issues as diverse as plans for a cultural district in West Kowloon in 2004 and a Goods and Services Tax to diversify its revenue base last year.

Mr Tung tried to tackle the problem in 2002 by filling some of the top civil-service posts with political appointees from business, the professions and academia. Legislators from “like-minded” parties and groups were appointed to ExCo to make it more like a cabinet in a democracy. Mr Tsang now proposes to extend the experiment with a new tier of political appointments to the civil service.

A basic contradiction
Tinkering with the existing structure in this way ignores the basic contradiction: that 60% of the electorate consistently votes for pro-democrats who are not “like-minded”. Yet their candidates are condemned to a minority of LegCo seats and exclusion from these political appointments. This is unlikely to change until the government in Beijing has a rethink, of which there is no sign. The DAB's Mr Tsang thinks that this year's contested chief-executive election will have reinforced its opposition to faster democratisation, despite Donald Tsang's strong popular support.

China had hoped to have him re-elected without a contest. It is still not ready to accept an alternation of ruling parties, fearing that some leading “democrats” are disloyal to China and want to topple Communist rule on the mainland as well. Popularly elected politicians, it reckons, might resort to populist measures (for example, bringing in a minimum wage). The world's biggest Communist party is afraid of democracy in Hong Kong lest it introduce an element of socialism there; and, perhaps, lest it inspire China politically, as it has economically.

Eternal vigilence

A respected legal system and a free press are proving competent watchdogs

AP

Lai holds the fort“THE rule of law and a free press”: government officials and businessmen repeat the phrase like a mantra that can ward off evil. They are not wrong. An impartial, trusted legal system and the free flow of information remain vital elements of Hong Kong's magic: two essential ways in which it is still not quite China. There were fears for both in 1997; both have survived, if not unscathed.

Worries about the legal system centred on the composition of the Court of Final Appeal (CFA) set up to replace Britain's Privy Council at the apex of the court structure. In fact, even strong critics of the arrangement put in place in 1995, such as Martin Lee, concede that the CFA has proved “very strong”. Where the law has looked in trouble it has been because of actual or perceived interference from either the Hong Kong or Chinese governments.

In 1999 the government refused to accept a ruling by the CFA on the rights of abode in Hong Kong of the mainland-born children of Hong Kong parents. It sought an “interpretation” of the relevant passages of the Basic Law from the National People's Congress, which duly overturned the CFA's ruling. On two other occasions the NPC has intervened: in 2004 to rule out universal suffrage in 2007-08; and in 2005 to decree that Donald Tsang's first term as chief executive would last only until 2007.

Nevertheless, the judicial system still enjoys respect at home and abroad. The solicitor-general, Ian Wingfield, is a Briton. He points out that Hong Kong does not even have an extradition treaty with the mainland. And the CFA, closer at hand and less prohibitively expensive to invoke than the Privy Council, has been much better used. Between July 1997 and the end of 2006 it received nearly 800 applications to appeal and nearly 300 substantive appeals, compared with just 103 appeals to the Privy Council in the previous decade.

Some businessmen are worried about a slow chipping away at legal standards. Newer judges, they say, are not of the same calibre as the older ones and may be more susceptible to political pressures. But many leading members of the opposition, such as Mr Lee and Mr Leong, are themselves lawyers, and neither shares that concern. Mr Leong, however, complains about a “lack of commitment to the rule of law”, citing examples where “administrative convenience and expediency took precedence”.

Whatever the worries about the judicial system, the police force, transformed from a byword for corruption in the 1970s to one of Asia's finest, is deemed to have managed the transition well. One of the 200-odd Britons still serving in the force laments the passing of its “mess culture” and the arrival of a more “autocratic” Chinese management style. But he sees no serious contamination from increased contacts with policemen from the mainland, where corruption is rife.

Keeping spin-doctors away
“I've been wrong,” is the rare and refreshing admission of Jimmy Lai, a clothing tycoon turned media mogul, about his pre-1997 gloom. In the 1990s sorrow over the Beijing massacre and trepidation about Hong Kong's future would sometimes reduce him to tears in interviews with the foreign press. Now he finds himself “pleasantly surprised by what has turned out”, especially in his own business. “Press freedom exists,” he declares.

There is, however, a sting in the tail: “We are the only ones holding the fort.” It is true that Mr Lai's Apple Daily newspaper and his weekly Next magazine are among the most outspokenly critical media, and that many other newspapers and their proprietors are, broadly, pro-government and pro-China. The Next group is suffering an advertising boycott from tycoons who do not want to upset China.

There are other, less subtle pressures. In May 2004 three popular radio talk-show hosts resigned, citing political pressure from mainland officials. A Hong Kong journalist, Ching Cheong, is in jail in China as a suspected spy. There are also fears of political motives behind a government-commissioned report this year on public-service broadcasting. It advised against turning Radio Television Hong Kong (RTHK), a government-owned but independent station, into Hong Kong's future public-service broadcaster.

But most journalists concur that a bigger problem than direct pressure is self-censorship. In a survey this year by the Hong Kong Journalists Association, 30% of journalists admitted to censoring themselves and 40% thought their colleagues did. One newspaper journalist recalls an editor's initial rejection of a column by a well-known Taiwanese independence activist. The column was published a week later, after the editor had reconsidered.

In other ways, too, freedom is still there for those who dare to exercise it. Falun Gong, a religious sect banned as subversive on the mainland, continues to proselytise in Hong Kong. And Han Dongfang, a labour activist who was a leading figure in the 1989 Tiananmen protest movement, lives and works there unmolested.

Every June 4th tens of thousands gather in Hong Kong's Victoria Park to commemorate the Beijing massacre. And, as mentioned earlier, on July 1st 2003 hundreds of thousands protested against planned anti-subversion legislation. They forced the government first into three big concessions in the bill and then into its deferral. It still has not been tabled and is “not a priority” for Mr Tsang's administration. Hong Kong knows the price of liberty and, inspiringly, seems prepared to pay it.

Rather them than us

Taiwan is not convinced by the Hong Kong experiment

HONG KONG is China's third attempt at implementing the idea of “one country, two systems”. Although the language was different, a similar promise—of a high degree of autonomy in everything except foreign affairs and defence—was offered to Tibet in 1951 and Taiwan in 1981. In neither place did it work.

In Tibet the autonomy soon proved illusory. In 1959 Tibetan resentment erupted in a revolt against Chinese rule, soon suppressed. Tibet's spiritual leader, the Dalai Lama, fled into exile with some 100,000 followers. Nowadays he is willing to accept Chinese sovereignty in return for genuine autonomy, but China will barely talk to his representatives.

Taiwan is a different matter. Bringing its 23m people back into the embrace of the “motherland” has always been more important to the Chinese even than reclaiming little Hong Kong from Britain and, in 1999, tiny Macau from Portugal. In 1981 China offered Taiwan even greater freedoms than those later promised to Hong Kong and Macau, including the right to maintain its own army. Taiwan at the time was ruled by the Nationalist Party, the Kuomintang (KMT), dominated by the minority on the island who had fled from China's Communists at the end of the mainland's civil war in 1949. The KMT spurned the offer, maintaining the fiction that it was the legitimate ruler of all of China. With Hong Kong, China had the chance to demonstrate to Taiwan that it could respect autonomy, preserve prosperity and make “two systems” work.

In the meantime Taiwan has become a democracy and the KMT has lost power to the Democratic Progressive Party (DPP), whose leaders lean towards a formal declaration of Taiwanese independence from the mainland. In that, few Taiwanese back them. China has never dropped its threat to “reunify” Taiwan by force if peaceful means fail. But opinion polls show that even fewer Taiwanese favour reunification along the lines of one country, two systems (see chart 3). They see little reason to swap de facto independence for a promise of autonomy, though some are ready to give China credit for keeping most of its promises in Hong Kong.

In Taiwan, as in Hong Kong, political development has been distorted by the relationship with China. The DPP's Chiou I-jen, secretary-general to the president, Chen Shui-bian, suggests that, in time, another similarity may become evident: that partial elections do not work. When Taiwan liberalised in the late 1980s, the opposition had no hope of winning elections because a majority of seats were reserved for delegates notionally representing seats in mainland China. The combination of relatively free elections and predetermined outcomes proved unsustainable in Taiwan, just as democrats hope it will in Hong Kong.

Light on its feet

The economy has been blowing hot and cold since the handover, but is now flourishing

REALISTS always knew precisely what would follow July 1st 1997: July 2nd 1997. Nor were those who watched financial markets all that surprised when that day brought a sharp devaluation in Thailand's currency, the baht, which had been under speculative attack for some months. But hardly anybody at all predicted that this event would, over the following few months, lead to the most severe regional financial turmoil for decades. Hong Kong, as a regional hub, was inevitably drawn into it. In comparison, the events of July 1st seemed almost irrelevant.

It took some time for the shock-waves from South-East Asia to reach Hong Kong. By the time they did, in 1998, it led to the worst recession in a generation, with GDP contracting by 5.5% that year. Prices fell for five years until modest inflation returned in 2004. A strong recovery in 1999-2000 was stalled by the slowdown in America after the bursting of the dotcom bubble. In late 2001 and early 2002 Hong Kong suffered another recession. Again, recovery was interrupted: this time by the outbreak of SARS in China in 2003, which caused some 300 deaths in Hong Kong and, for a while, crippled the economy.

After three years of recovery, the tenth-anniversary celebrations are held against the more familiar backdrop of thronged shopping malls, packed restaurants and a welter of impressive statistics. The economy grew by 7.5% in 2005 and 6.9% last year. Trade has increased by two-thirds since 1997. More visitors are coming to Hong Kong than ever before—more than 25m a year. It is the world's third-biggest air-cargo hub and second-biggest container port by throughput. Hong Kong continues to top lists of the world's “freest economies”.

That last attribute helps explain the flexibility and impressive strength Hong Kong has shown since 1997 to withstand the battering from so many unforeseen assailants. So, too, does the good shape it was in at the time of the handover, and particularly its extraordinarily strong fiscal position. This was in part a defence against the political uncertainties of the handover, and in part a reflection of China's abiding fear that Britain would empty the safes and cupboards before departing. Although Hong Kong's financial autonomy is guaranteed under the Basic Law, China demanded consultation on the final budget of British rule, prepared by Donald Tsang, the financial secretary at the time.

The all-too-visible hand
The war-chest built up for one campaign proved useful for a different one altogether. In August 1998 the Hong Kong government spent HK$118 billion buying shares on the local stockmarket in response to speculative attacks from hedge funds. Since October 1983 the Hong Kong dollar has been pegged to the US dollar. The peg is backed by a currency board (ie, every Hong Kong dollar is backed by equivalent holdings of US dollars). Attacks on the peg automatically lead to a rise in interest rates, which depresses the stockmarket. So speculators against the HK dollar would also “short” the stockmarket, making money as the market lost value. Because of the peg, the exchange rate remained immune from the contagious devaluations that swept Asia in 1997-98. But the price was paid in five years of deflation and crashing asset prices. Property prices fell by 60-70% from their 1997 peak.

Having intervened in the market—rightly or wrongly—Mr Tsang gained credit for holding his nerve as the scale of the intervention mounted. Alarm about a more active role for the government in the economy turned out to be partly justified. Government officials dropped the rhetoric of non-intervention and adopted slogans such as “proactive market enabler”. But the practical impact of this should not be exaggerated. The government ran fiscal deficits for a number of years from 1998, and expenditure as a percentage of GDP rose as the recession bit. But by 2006 it was back in surplus and its spending ran to only about 17% of GDP, compared with an average for the OECD countries of over 40%.

Even so, critics have accused the government—especially under Mr Tung—of being more partial than its colonial predecessor to three sorts of distorting government activity: picking winners; investing in what should be private-sector projects; and backing favourites. These strands came together in 1999 in the Cyberport project, a property development disguised as an information-technology initiative, negotiated with the Pacific Century Group of Li Ka-shing, the most redoubtable of Hong Kong tycoons. And the decision to put government money into Hong Kong's own Disneyland, which opened in 2005, remains controversial.

Spending taxpayers' money on such projects lays the government open to attack from critics who say its safety net for the poor remains inadequate, despite an increase in social-welfare spending from 1.6% of GDP in 1997 to 2.4% last year. Such criticism has grown louder in two recessions since 1997. Unemployment before the handover, at about 2% of the workforce, was almost negligible. It climbed to 6.2% in 1999 and 7.9% in 2003. Since then it has fallen every year, but at 4.8% in 2006 was still much higher than pre-handover levels. Over the same period median earnings—about HK$10,000 a month—have not changed at all.

Inequality, as measured by the Gini coefficient, has been rising since 1981 and now compares badly with other developed economies, being roughly on a par with Argentina. The government's financial secretary, Henry Tang, argues that this is a global trend which a small, open economy such as Hong Kong's can hardly resist. Even Alasdair Morrison, former chairman in Asia of Morgan Stanley, a leading investment bank, frets that the ordinary citizen is not getting enough out of Hong Kong's huge success as a global financial centre.

That success is ever more linked to China's soaring economic growth. Hong Kong is still the largest investor in China. Its firms employ an estimated 12m people there. The share of China's trade intermediated by Hong Kong has fallen from about 60% in the 1980s to about 20% now, but the absolute amount has more than doubled since 1996, to $300 billion last year, despite a loss of market share to mainland ports.

Integration with the mainland Chinese economy began in the early 1980s and in many respects has developed independently of the political relationship. Hong Kong remains a separate customs area, with its own fully convertible currency. In the early 1980s Hong Kong still had a manufacturing industry. Rising costs made moving to China an obvious choice.

The transformation of the mainland Chinese economy in the past three decades is well-documented. But on a smaller scale, Hong Kong's own evolution from a low-cost manufacturing base to a hub for services with ever more value added (see chart 5) is almost as remarkable. It has been achieved in symbiosis with the mainland. This gives rise to two common but diametrically opposed prognoses for Hong Kong's economic future.

Pessimists still see Hong Kong as doomed, despite the present rosy outlook. Its fate is now tied inextricably to China's. There are already signs that the mainland economy is overheating. Should it crash, it will drag Hong Kong down with it. But should the mainland boom continue, Hong Kong's importance will steadily diminish compared with other Chinese cities, notably Shanghai. Once China's currency, the yuan, is fully convertible, Hong Kong will be just another Chinese port.

Optimists point to the big helping hand China extended to Hong Kong in the second half of 2003. In the depths of the post-SARS gloom, China came to the rescue in two ways. The “Closer Economic Partnership Arrangement” (CEPA) signed at the time is a free-trade agreement giving Hong Kong firms preferential access to the mainland market. More important, China allowed individual Chinese travellers to visit Hong Kong without joining group tours—a big boost to the local tourist and retail industries. Even if things go badly on the mainland, say the optimists, it will try to spare Hong Kong the worst. And since the city is still integrated into world markets as well as China's, it is somewhat insulated from a downturn in China alone. If Chinese growth continues at its present astonishing rates, however, Hong Kong will continue to share in the feast.

The truth lies somewhere between these extremes: neither success nor failure is inevitable. Hong Kong is too much part of China's economic region not to be dependent on growth there. And it is likely that Shanghai will take away some of Hong Kong's business. Still, even a declining market share in China can mean huge absolute increases, and Hong Kong is uniquely placed to gain from continued growth in its own backyard.

Richer than all his tribe

The workshop to Hong Kong's front office

ONE fear about Hong Kong's future is that the rise of Shanghai might condemn it to becoming the financial hub for “just” the Pearl River Delta (PRD), as Shanghai deals with the booming Yangzi delta region. The worries are premature, such is Hong Kong's lead over Shanghai. But even if they were realised, such a fate might not be the end of Hong Kong.

The PRD is, with the Yangzi delta and the Bohai rim around Beijing and Tianjin in northern China, one of the three most important economic regions of China. The “PRD Economic Zone”, first officially defined in China in 1984, includes the “special economic zones” of Shenzhen, next to Hong Kong, and Zhuhai, bordering Macau, and the neighbouring parts of Guangdong province.

According to a study in 2005 by Michael Enright, Edith Scott and Ka-mun Chang, if the area, including Hong Kong and Macau, were a separate country, it would be the world's 18th-largest economy and its 11th-biggest exporter, ahead of South Korea and India. It has a population of about 65m and the mainland part of it has enjoyed an astonishing average annual rate of economic growth of around 17% for the past quarter-century. Hong Kong firms employ more than 11m people in the region and have provided some two-thirds of the foreign direct investment there. The mainland part of the region has attracted about 22% of all the FDI that has gone into China and accounts for about one-third of its exports and imports. Two-thirds of the world's toys, 45% of its wristwatches and one-third of its consumer electronics, garments and footwear are made there.

No other country in the world has industrialised as rapidly as China; and within China no region has matched the sustained growth of the PRD. To the outside observer it looks hideous: a proliferation of ugly building sites, cramped factories, poisoned waters and filthy smokestacks. Yet there are signs that the region is ready to move upmarket.

Air pollution is now causing a growing clamour and land turns out to have a myriad valuable uses. Wages have gone up, so the number of sweatshops has gone down. K.C. Kwok, the Hong Kong government's economist, says some local governments in the Pearl River Delta are establishing links with officials in Vietnam and Bangladesh to refer potential investors on to them. There is also a “Pan-PRD initiative”, covering the nine southern provinces of China, to help spread development from the congested coast to the poorer inland regions. This, says the Hong Kong government, will position Hong Kong as the hub of a region of 474m people, with a GDP much the same as that of the ten members of the Association of South-East Asian Nations combined. Eat your heart out, Lee Kuan Yew.

Smog gets in your eyes

There is doubt about the government's commitment to protecting the environment

MUCH of the border between the New Territories and China is a stark divide. On one side are tower-blocks and the frenetic building of a modern city; on the other rugged, deserted hillsides interspersed with farmland. Hong Kong's countryside is one of its lesser-known glories. Some 37% of its territory is protected in country parks—a remarkable proportion in one of the world's most densely populated places. The corollary is that most Hong Kongers live in small, high-rise apartments arranged along deep canyons. And their natural environment, they believe, is worsening steadily.

Civic Exchange, a think-tank, sums up a common view in a ten-year review of Hong Kong's environment: “Environmental quality is failing to improve, or even deteriorating in many areas...There is a lack of leadership from the highest level of the government on environmental issues, and a continuing reliance on an infrastructure-led economic model that is exacerbating environmental problems.”

The problem that gets the most attention, and that most shocks returning visitors, is the deterioration of the air quality. This started well before 1997. Civic Exchange cites an estimate based on 1996 statistics which put the additional premature deaths per year resulting from air pollution at 2,000. A commonly used current estimate comes from Anthony Hedley of the University of Hong Kong, who calculates that bad air causes 1,600 deaths a year.

Besides such grim numbers, there are two other reasons why air pollution has become such a huge concern. The first is its visibility—in the form of smog, which has become steadily more common (see chart 6). The magnificent views from those soaring skyscrapers in Hong Kong's Central District are often shrouded in haze. The second is that this is starting to deter people who have a choice from living in Hong Kong.

The air is as bad as in any rich-world city. Sarah Liao, the government's environment secretary, says the sea breeze often used to save Hong Kong from the effects of filling the atmosphere with so many poisons. But now “we have got to the stage where nature says 'no-can-do'...We are swimming in a constant chemical soup.”

A government handout insists that “improving air quality tops the government's agenda”. And Ms Liao gives an impressive list of initiatives, including trying to change individual behaviour. She has been urging building managers to turn up the thermostats on their air-conditioning, and drivers to turn off idling car engines. Now she is contemplating legislation. Emission caps have been imposed on power companies, and Ms Liao says that in the negotiations to set new electricity tariffs from next year, pollution control will be as important as volume generated (almost the sole criterion in the present arrangements). Already, all taxis and half the minibuses have been converted to run on less polluting LPG.

Much pollution, of course, comes from mainland China. The same handout suggests that the Pearl River Delta is the source of roughly four-fifths of the pollution. But another study by Civic Exchange found that last year local emissions were the main cause of pollution on 192 days and mainland emissions on 132. Only 41 days were fairly low on pollution.

Many of the polluting factories on the mainland are owned by Hong Kong businesses. It seems that local authorities in China are getting tougher on the worst offenders. But environmentalists believe that Hong Kong's government is not doing enough to persuade mainland local authorities to help: it is “self-intimidated”, according to Eric Bohm, who heads the local office of WWF, a conservation body.

Mr Bohm says the government has decided green groups are “anti-development”. Despite its denials, it is also widely believed to see air pollution as an expatriate's concern, at odds with the hunger of local people for growth. And Donald Tsang's “legitimacy deficit” lays him open to the charge that he is more concerned about the interests of the local businessmen who helped to elect him than those of the average breather.

A tale of two hongs

And two ways of handling a handover

Corbis

When Jardine was a babyTHE rivalry between the old colonial trading houses—the hongs—that used to dominate business in Hong Kong is the stuff of legend. As Hong Kong's reversion to China loomed, two of the crustiest adopted opposite strategies. Jardine Matheson, founded in 1832 and still commemorated in a number of Hong Kong place names, confronted the Chinese authorities and became, say its bosses, a “whipping boy to beat up the British”. In contrast, Swire, heir to Butterfield & Swire, in business in China since 1861, seemed eager to please. In 1996 it sold 25% of Cathay Pacific, Hong Kong's “flag-carrier” airline—to CITIC, a Chinese investment firm, and other mainland investors.

Jardine's fall into disfavour followed its decision in 1984 to shift its legal domicile to Bermuda, and then, a decade later, to delist its shares from the Hong Kong market. Both moves dented commercial confidence at sensitive moments. It did not help when Henry Keswick, Jardine's chairman, told a British parliamentary committee in 1989 that Britain was handing Hong Kong over to a “Marxist-Leninist, thuggish, oppressive regime”. Chinese polemicists have long historical memories and linked the fleet-footedness and insults to Jardine's role in the 19th-century opium trade.

Chinese pique was such that, for much of the 1990s, it would have no truck with Jardine. But ten years on, Mr Keswick says, “business has never thrived better.” There is no “post-colonial kickback”. The group remains Hong Kong's biggest employer outside the government. In the past ten years its shares have shown a compound annual growth rate of 21.3%. One subsidiary, Hongkong Land, owns much of the territory's best office space. Others are big in construction, engineering and supermarkets. One-quarter of its revenues derive from Hong Kong and China, and most of the rest from South-East Asia. This, says Mr Keswick, is one of Hong Kong's wonders often overlooked in the euphoria about China: it is the centre of an overseas Chinese commercial diaspora spanning the region.

As Jardine has found before, however, Chinese leaders bear long grudges. Despite the present boom, it may be too early to celebrate reconciliation. And if Jardine can claim vindication for its strategy, so can Swire. It is similarly diversified. But an airline deal it struck last year symbolises the interlocking business interests of Hong Kong and China. Swire gained 100% ownership of Dragonair, a mainly domestic Chinese airline, and doubled its shareholding in Air China, the national flag-carrier, to 20%. Swire and CITIC both reduced their holdings in Cathay and Air China bought 17.5% of it. The arrangement prompted some to ask, as they do of Hong Kong and China, “who took over whom?”

Life on the margin

To secure its future as a world city, Hong Kong needs democracy Digital Vision HAVING grown up to the ticking of a countdown clock, many Hong Kongers have been worrying most of their lives. But Liu Kin-ming, a former head of the Hong Kong Journalists Association, points out that their worries now are the exact mirror image of their fears in 1997. Then the concern was that China would meddle in Hong Kong too much, destroying a cherished way of life and a purringly efficient economy. Now the fear is that Hong Kong will be “marginalised”: that China will not meddle enough.

Nowhere is this feeling more acute than in the financial markets. As financial services have steadily grown in relative economic importance, so has exposure to any fickleness in Beijing's policies. This is particularly true of the stockmarket. Last year the amount of capital raised in initial public offerings (IPOs) in Hong Kong was second only to that in London. Some 73% of the Hong Kong total, or HK$369 billion, was raised by mainland enterprises. By the end of 2006, 367 mainland companies had listed shares in Hong Kong. They account for 55% of the capital raised in Hong Kong in that period and now make up nearly one-third of listed companies, half the stockmarket's capitalisation and 60% of its turnover.

They also help explain the burgeoning operations of the big global investment banks that are competing for a slice of this lucrative market, and their worries that the flow of big mainland IPOs might dry up. There are two concerns. The first is that many of the very biggest deals have already been done. The second is that the Chinese authorities might start forcing more companies to list shares in Shanghai rather than—or as well as—in Hong Kong.

In the short term, some of this is a response to the spectacular bubble on the Shanghai exchange this year. As millions of Chinese citizens have discovered the thrill of gambling on the stockmarket, share prices there have soared. By May, the 40-odd shares listed in both Shanghai and Hong Kong were trading in Hong Kong at an average discount of 43% to those on the mainland. Besides the attractions to share issuers of such high prices in Shanghai, the clear signs that too much cash was chasing too few shares have encouraged regulators to increase the supply of listed companies.

In the longer term, China may indeed want to see Shanghai become a truly global financial centre. Already it is taking steps to improve corporate governance, disclosure and accounting standards. It needs to. According to a ranking of Asian companies in 2005 by the Asian Corporate Governance Association, a private-sector watchdog, China came ninth out of ten, whereas Hong Kong came second, behind Singapore. Nevertheless, Goldman Sachs, in an assessment of Hong Kong Exchanges, the listed company running the stockmarket, fretted about the perception of its “eroding pre-eminence” compared with Shanghai. But Paul Chow, chief executive of Hong Kong Exchanges, says that “battle has not started” because the yuan is not fully convertible.

Open for business
Mr Chow may well be right that Hong Kong need not worry yet. It is so far ahead of Shanghai in terms of institutions, laws, connections and English-speakers that catching up will take decades. As China's prime minister, Wen Jiabao, put it himself this year, “Hong Kong's position as a financial centre, shipping centre and trade centre is irreplaceable.”

Even if the IPO bonanza were to peter out, there would be other opportunities. For example, China says it wants to invest $300 billion of its foreign-exchange reserves. And if China were to open up further and liberalise its exchange rate, Hong Kong would benefit so much that a loss of market share might be almost irrelevant.

The same factors that make Hong Kong an appealing Asian foothold for financial institutions attract other businesses too. Hong Kong still has 6,300 offices of Chinese and foreign companies. Nearly 4,000 of these are “regional headquarters”, drawn not just by Hong Kong's reliable legal system and free flow of information but by its efficient, well-connected airport. It is hard, for example, to cover Taiwan, the world's 16th-largest exporter and importer, out of mainland China, because there are no direct scheduled flights.

However, there are signs that Hong Kong is becoming less appealing as a base for Westerners. Estimates from Hong Kong's immigration department of the number of Western expatriates fell by about one-third between 2001 and last year, to just over 70,000. Among the factors blamed are air pollution, a shortage of places in international schools and the sky-high price of top-quality accommodation. But the growing role of China in the local economy, generating more jobs that can be filled by local people, may also have something to do with it. And some Western expatriates who have stayed say that far more of them are buying property and investing in Hong Kong for the long term than before 1997.

It is certainly not that foreigners are fleeing because the darkest forebodings have come true and China has made Hong Kong a bad place to do business. When the Chinese government has intervened directly in Hong Kong's business affairs, it has met with vigorous opposition. Last year, for example, there was a row over Hong Kong's largest telecoms firm, PCCW, whose chairman and main shareholder, Richard Li (Li Ka-shing's son), tried to sell the firm's main assets to a foreign consortium. The deal began to crumble when a Chinese firm, China Netcom, which owned 20% of PCCW, objected to the sale. An agreement reached when China Netcom acquired its stake in PCCW in 2005 had in effect given it a veto over any large share sales. The company was reported to have been acting under instruction from Liao Hui, the head of China's Hong Kong and Macau Affairs Office. China is not alone in discriminating against foreign would-be purchasers of strategic assets. Its own attempted takeover of Unocal, a Californian oil firm, in 2005 was scuppered by American concerns about ceding ownership to China. Even so, the affair was a serious breach of Hong Kong's commercial autonomy.

Such incidents, despite dire warnings, have not so far done any fundamental damage to Hong Kong. Even before the handover, China's commercial clout was felt in the influence of its big enterprises in Hong Kong and the belief of both Hong Kong and foreign businesses that it made sense to cultivate them. Those businessmen that displeased China, such as Jardine's bosses (see article), or Jimmy Lai, who was hounded out of his successful clothing chain, Giordano, suffered the short-term consequences.

Yet in most respects China has honoured the promise of “Hong Kong people ruling Hong Kong” with a high degree of autonomy. The exception, however, makes a mockery of the other promises: Hong Kong's continued inability to choose its own political representatives and leaders. China utterly refuses to yield that kind of autonomy to Hong Kong; indeed it is prepared to intervene egregiously in Hong Kong's affairs through its support for the candidates it favours in Hong Kong's “partial” elections and through its “interpretations” of the Basic Law to make sure those elections remain partial. The response from the present Hong Kong government mimics the “pre-emptive cringe” of pre-Patten British colonial regimes. Rather than stand up for the rights of Hong Kong's people, it is inclined to second-guess the views of the government in Beijing.

Asia's world city
Such a puppet government will find it hard to deliver decisive leadership, and will remain vulnerable to attacks on its legitimacy. With their big demonstration on July 1st 2003, Hong Kong's people not only achieved the indefinite delay of an objectionable piece of legislation; they also, in effect, brought down the government of Tung Chee-hwa. But the conclusion the Chinese government seems to have drawn from the episode is depressing: that full democracy should be deferred further, perhaps for ever. That may be unwise. According to Lord Patten, Hong Kong is a moderate place and no threat to China, but “if there is one thing that could make Hong Kong immoderate, it is blocking attempts to introduce more accountability into the political system.”

At times in Hong Kong's recent history its political system has been a matter of global interest: at the time of the Joint Declaration in 1984; after the massacre in Beijing in 1989; and in the years around the handover in 1997. Ten years on China has managed to make Hong Kong's political demands seem an almost parochial concern. Britain's Foreign Office produces a restrained six-monthly report on the territory, and American politicians occasionally raise the issue with China. But nobody pretends that foreign governments have much leverage.

China clearly has an interest in Hong Kong's success, but cares even more about its stability. That is especially true as China readies itself for the 2008 Olympics, to be held in Beijing—except for the equestrian events, which will be staged in Hong Kong because of the prevalence of equine diseases in Beijing and other mainland cities. Is this a metaphor for what Hong Kong has become: a useful adjunct to the mainland, with better quarantine arrangements?

It is still much more than that; still, in the slogan trumpeted by its government, “Asia's world city”. Hong Kong remains China's pre-eminent international city, competing with London and New York as much as with Shanghai and Singapore. The biggest risk to this status remains China's bizarre idea that it can be an “economic” city without being a “political” one. And its best defence remains the extraordinary resourcefulness, common sense and vigilance of its people.