RS20786 -- Hong Kong-U.S. Economic Relations Updated January 27, 2005 With a population of 6.8 million, Hong Kong is one of the world's most vibrant economies and a major center forinternational banking and foreign trade. It is utilized by many foreign companies as a gateway to markets inmainlandChina. With a per capita GDP of $27,700 on a purchasing power parity basis in 2003, Hong Kong maintains thesecond highest standard of living in Asia (after Japan); it is higher than that of many West European nations,includingGermany and the United Kingdom. Hong Kong is a member of a variety of multilateral economic organizations,suchas the World Trade Organization (WTO) and the Asia Pacific Economic Cooperation (APEC) forum. Hong Kong's economy is heavily dependent on trade. (3) In 2004, Hong Kong's merchandise exports and imports were$259 billion and $271 billion, respectively. A large share of Hong Kong's trade consists of entrepot and processingtrade, much of it involving China. (4) About 30% ofChina's trade passes through Hong Kong. Taiwan, which does notmaintain direct commercial links with China, ships most of its exports to, and imports from, China via Hong Kong. Alarge share of China's exports also pass through Hong Kong before being re-exported to other destinations. Someofthis trade consists of products made by Hong Kong firms in the Mainland, which are sent to Hong Kong for furtherprocessing before being re-exported elsewhere. Hong Kong has transferred a large share of its manufacturing basetothe Mainland. In the Pearl River Delta region (Guangdong Province, China), 50,000 Hong Kong firms employabout 6million Chinese workers, 20 times the size of Hong Kong's manufacturing workforce. As a result, the importanceofmanufacturing to Hong Kong's economy has diminished in recent years, while that of services (especially thoserelating to trade, such as banking and financial services) has increased sharply. In 2004, services exports andimportswere estimated to total $65 billion and $36 billion, respectively. Hong Kong has enjoyed relatively healthy growth over the past several years. However, in 1997 Hong Kong's economy was hit by the Asian financial crisis. Beginning in July 1997, speculative pressures on the Hong Kongdollar(which has been pegged to the U.S. dollar since 1983) caused the Hong Kong Monetary Authority (HKMA) to spend$1 billion to prop up the currency. These pressures continued, leading the HKMA in October 1997 to raise interestrates (to stop capital flight), which subsequently led to a nearly one-quarter drop in the Hong Kong stock market(theHang Seng Index) over a four-day period. In late August 1998, the Hong Kong government intervened in the stockmarket's decline by spending $15 billion to purchase shares from 33 blue-chip companies that make up the HangSengIndex, which helped raise the value of the shares by 24%. Several analysts criticized the government's intervention,arguing that it violated Hong Kong's free market principles by increasing the government's role over the economy. The Hong Kong government maintained that its intervention was a one-time event, intended to halt speculation andstabilize the stock market. (5) The effects of the Asian economic crisis on Hong Kong were significant. The economy fell into a major recession in1998: real GDP fell by 5.0%, the unemployment rate rose from 2.2% to 4.7%, and exports and imports declinedsharply. The Hong Kong economy recovered somewhat in 1999 and 2000, but was negatively affected by theterroristattacks against the United States in 2001 and by the outbreak and spread of a new and deadly virus called SevereAcuteRespiratory Syndrome (SARS) in 2003. Hong Kong was one of the areas hardest hit areas by SARS, whichdrasticallyreduced tourism and domestic demand. By the end of June 2003, the unemployment rate rose to a record high 8.7%. Hong Kong's economy picked up sharply in 2004, due to rising exports and strong domestic demand. Real GDP grewby an estimated 7.7%; however, unemployment remained stubbornly high (see Table 1 ) Table 1. Selected Economic Data for Hong Kong, 1997-2004* *Data for 2004 are estimates. Date on unemployment is average of the last three months ending in November 2004. Sources: Hong Kong Trade Development Council, Hong Kong Census and StatisticsDepartment, the EconomistIntelligence Unit, and Global Insight. The United States is one of Hong Kong's most important economic partners. In 2003, the United States was HongKong's largest market for domestic exports (i.e., products made in Hong Kong) and its fourth-largest supplier ofimports. There are over 1,000 U.S. businesses represented in Hong Kong, including more than 400 regionaloperations; more than 50,000 U.S. citizens reside in Hong Kong. Cumulative U.S. foreign direct investment (FDI)inHong Kong at the end of 2003 was $44.3 billion. (6) Many U.S. firms and investors seeking to do business in Chinahave used Hong Kong as a base for their operations, frequently relying on Hong Kong partners to obtain the"guanxi"(connections) that are often needed to gain access to China's markets. In 2004, it is estimated that Hong Kong was the thirteenth-largest purchaser of U.S. exports ($16.0 billion) and thetwenty-seventh-largest supplier of U.S. imports ($9.3 billion). The top three U.S. exports to Hong Kong in 2005wereelectrical and electronic machinery and parts (mainly electronic integrated circuits, micro-assemblies, andsemiconductors), non-electrical machinery (such as computers and computer parts), and miscellaneous manufactureditems (mainly diamonds and jewelry). The top three U.S. imports from Hong Kong were apparel and clothing,miscellaneous manufactured commodities, and telecommunications and sound equipment (see Table2 ). Table 2. Major U.S.-Hong Kong Trade Commodities, 2000-2004 ($ in billions) SITC Classification, two-digit level. Source : U.S. Commerce Department. Date for 2004 estimated based on actual data forJan.-Nov. 2004. The United States continues to treat Hong Kong as a separate economic territory for such purposes as trade dataandexport controls. U.S. officials continue to work with Hong Kong officials to ensure that Hong Kong is not used byChina to illegally circumvent U.S. controls on exports of dual-use and other high technology products and to combatviolations of U.S. intellectual property rights (IPR) in Hong Kong. (7) Export Controls. The United States seeks to control exports of dual-use technologies for a variety of national security and foreign policy purposes through a complex regulatorysystem of export license requirements. Despite the reversion of Hong Kong to Chinese sovereignty, the UnitedStatescontinues to treat Hong Kong separately from the Mainland for export control purposes (i.e., controls of U.S. exportsof dual-use items to Hong Kong are far less restrictive than those to China). Some Members of Congress haveraisedconcern that China may be using Hong Kong to acquire dual-use items that cannot be obtained directly from theUnited States, and have called for tighter controls on U.S. exports to Hong Kong. The United States-Hong Kong Policy Act of 1992 ( P.L. 102-383 ) requires the U.S. State Department to report periodically to Congress on conditions in Hong Kong and its relations with the United States, including cooperationinthe area of export controls. In its most recent report (April 2004), the State Department stated that "Hong Kong maintains an effective, highly autonomous, and transparent export control regime that the U.S. government hasencouraged others to emulate." However, the report stated that the growing economic integration between ChinaandHong Kong has presented new challenges to ensure effective compliance with export control regimes, and notedthatover the past two years, inspections have uncovered an increase in instances of illegal re-exports of U.S. dual-usetechnology to China. Hong Kong and U.S. officials have agreed to boost cooperation on the sharing of licensingandenforcement information and to education the Hong Kong public of export control laws. (8) IPR Protection. Over the past few years, the United States has pressed Hong Kong to improve its IPR protection regime. From April 1997 to February 1999, Hong Kong wasdesignated by U.S. Trade Representative (USTR) under Special 301 , (a provision of U.S. trade lawdealing withcountries that violate U.S. IPR) as a watch list country due to the widespread distribution and retail salein Hong Kongof pirated compact discs. (9) Hong Kong was removedfrom the Special 301 watch list after the USTR determined thatHong Kong had made significant improvements to its legal regime and enforcement efforts. The 2001 and 2002Special 301 reports listed Hong Kong as one of several trading partners in which progress in protection of IPR hadbeen made. The USTR's 2003 IPR report praised the Hong Kong government for requiring government agenciestouse only legitimate software and for its commitment to halt optical media piracy. The 2003 State Department reportstated that Hong Kong had "shut down virtually all large-scale illicit manufacturing lines," but noted deficienciesintwo areas: commercial end-use piracy and patent projection for pharmaceuticals. (10) Several international economic forecasting organizations contend that the long-term prospects for Hong Kong's economic future remain relatively positive, provided that it continues to employ free trade, market-oriented policies,and maintains its autonomy from mainland China. (11) The Economist Intelligence Unit projects that Hong Kong'seconomy will grow by 4.7% in 2005 and 3.6% in 2005, while Global Insight projects real GDP growthat 4.9% and4.4%, respectively. (12) China's accession to the WTO (which occurred in December 2001) poses both opportunities and challenges to HongKong's economy. On the one hand, the removal of trade and investment barriers by China will likely significantlyboost Hong Kong trade with, and investment in, the Mainland. Hong Kong is already by far the largest investor inChina (and China is the largest investor in Hong Kong), and hence is likely to be in the best position to takeadvantageof a more open Chinese market. In addition, China's WTO accession is expected to sharply increase its trade flows,and much of that increased trade will likely take place via Hong Kong. (13) On the other hand, a more open Chinesemarket could diminish Hong Kong's role as a middleman for foreign firms wanting to do business with theMainland,especially if foreign investors believe that the rule of law, rather than "connections," will be the primary factorgoverning business relations in China. Hong Kong's economy could also be negatively affected if China and Taiwandecide to establish direct trade links, which would likely reduce the level of trade that takes place via Hong Kong. (14)

Summary: Hong Kong is described by many observers as having the world's freesteconomy due to its low tax, free trade, and strong rule of law policies. Hong Kong is an important U.S. tradingpartnerand serves as a gateway for many U.S. companies doing business in China. For those reasons, the continuedeconomicautonomy of Hong Kong is of concern to Congress, as are a variety of trade issues such as the effectiveness of HongKong's export control regime on dual-use technologies, and protection of U.S. intellectual property rights. China. This report will be updated as events warrant.