Hong Kong Industries: The Way Forward

MADE IN 2015 Hong Kong Industries: The Way Forward Sponsors:

The Made in PRD 2015 Study Hong Kong Industries: The Way Forward is a Federation of Hong Kong Industries (FHKI) project. It was commissioned to the China Business Centre of the Hong Kong Polytechnic University. The Study was sponsored by HSBC Commercial Banking and the Hong Kong Polytechnic University. The FHKI sincerely thanks them for their generous support. 2015 Federation of Hong Kong Industries All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a data base or retrieval system, without the prior written permission of the Federation of Hong Kong Industries. Website: http://www.industryhk.org

Hong Kong Industries: The Way Forward Table of Contents Foreword 2 Preface 6 Hong Kong Industries and Made in the Pearl River Delta (PRD) 6 Introducing the Study 9 Chapter 1 The Transformation of Manufacturing in the PRD 10 Change in Market Direction of Manufacturing in the PRD 11 Changes in Manufacturing Structure in the PRD 13 Development of PRD Business Policies 16 Trends in the PRD Business Environment 26 Chapter 2 Hong Kong Manufacturers in the PRD Seek Changes 29 Industrial Scale and Structure of Manufacturers 29 Operating Model of Manufacturers 32 Transformation of Manufacturers 39 Future Development Directions of Manufacturers 45 Chapter 3 Development Challenges of Hong Kong Industries 50 Manufacturing in the PRD 50 Human Resources 50 Scientific Research and Innovation 51 Expanding Sales in the Mainland 52 Succession in Industries 53 Returning to Hong Kong 53 Summary of the Challenges Facing Hong Kong Industries 56 Chapter 4 Development Trends of Hong Kong Industries 62 New Directions in International Industries 62 China s New Industrial Trends 67 New Opportunities for Hong Kong Industries 74 Hong Kong Industries and Industrial Policy 75 Chapter 5 Policy Proposals 79 Development Objectives 79 Comprehensive Plan for Hong Kong Industrial Policy 82 Actively Promote External Industrial Co-operation 97 Appendices 102 Appendix 1: Summary of Focus Group Discussion 102 Appendix 2: Questionnaire 120

2 Foreword Since the global financial tsunami in 2008, we have witnessed changes in industries worldwide. Driven by specific strategies including re-industrialisation in Europe and the US, Industry 4.0 in Germany, Advanced Manufacturing Partnership in the US and Made in China 2025 in China, there has been an increase in the construction of information-based infrastructure for industrial internets. This new manufacturing mode includes using smart production, big data and the promotion of the internet era. All these are gradually forming new structural changes in global industrial development. In particular, Made in China 2025 advocates the Internet Plus Manufacturing Mode, smart manufacturing, green production, as well as the transformation from a manufacturing-oriented production to a serviceoriented one. These initiatives alter the co-operation modes of Hong Kong and the Mainland, especially in the Pearl River Delta (PRD) region. Hong Kong s industrial sector has been keeping up with the latest development trends in the external economic environment and seeking for transformation and upgrading through developing environmental technologies and green production, increasing research and development (R&D) activities and entering into new industries and business fields in the form of investment, while a new generation of R&D-based enterprises is also emerging. At present, there are ample opportunities for Hong Kong industrial development brought about by Made in China 2025 and industrial policies in the PRD region. Initiatives including smart manufacturing, green production, service-oriented manufacturing, and integration of the internet and the manufacturing industry have been proposed, capitalising on the major trends of global industrial development. The industrial sector of Hong Kong can engage in these developing fields in the Mainland and leverage its advantages in servicing to foster the transformation and upgrading of Hong Kong manufacturers operating in the PRD region. On the other hand, Hong Kong, as an international metropolis, is an international finance and service centre in the region. Equipped with a well-established intellectual property system, Hong Kong is notably suitable for launching projects on cross-national industrial R&D co-operations for developing knowledge-based manufacturing modes.

3 The focus of this Study is to understand the changes in the operational environment in the PRD region and the modes of business of Hong Kong enterprises from 2008 onwards. This will help explore how the related industry players including Hong Kong manufacturers, production service providers, R&D institutions and university graduates assess the current situations and plan ahead for the future. The report details a range of recommendations on how to drive the sustainable development of Hong Kong industries. The focus is a comprehensive set of industrial policies and systems to increase Hong Kong s industrial resources, enhance its industrial competitiveness, boost a diversified development and improve the environment conducive to its industrial development. The Study findings show that the operational environment in the PRD, in areas of the import and export clearance as well as the electricity supply, has improved. But enterprises are still under substantial pressure with concerns over labour shortages, soaring production costs and the tightening up of labour laws. In the face of acute challenges rising from these new changes, we are pleased to see that many Hong Kong manufacturers have adopted proactive measures. In fact, the manufacturing industry is an indispensable part of the economy and livelihoods (as in clothing, food, housing and transportation). While Hong Kong devotes efforts to develop the service sector including finance, logistics, tourism and retail, it should also strengthen its industries as a key pillar in its real economy to secure a solid economic base. In the face of the shuffling changes brought about by the Internet Plus era to the market, technology and manufacturing activities, Hong Kong industrial enterprises, the production service providers as well as the Government should all take proactive steps to adjust and transform themselves accordingly, to respond to the challenges of industrial structural changes and strive for another breakthrough for Hong Kong industries. The Federation of Hong Kong Industries will continue to assist our members and other organisations to engage in this endeavour. Professor Daniel M Cheng Chairman, Federation of Hong Kong Industries October 2015

4 The Mainland has stepped into the period of the 13 th Five Year Plan, which is also the beginning stage of the Belt and Road Initiative. Its economic reforms are believed to continue to deepen and Hong Kong should seize the opportunities brought about by these developments. The release of the 2015 Made in PRD Study: Hong Kong Industries: The Way Forward comes at the right time. It principally describes the changes of the operating conditions of Hong Kong enterprises in the Pearl River Delta (PRD) region since 2008 and their future operational directions, thus exploring the road ahead for Hong Kong industries. Since 2002, the Federation of Hong Kong Industries (FHKI) has carried out regular investigations into manufacturing in the PRD region with a view to assisting Hong Kong enterprises development in the region. The Hong Kong Industries: The Way Forward is a report on results of a questionnaire survey conducted by the research team led by Dr Thomas Chan, Head of China Business Centre of the Hong Kong Polytechnic University, from March to December 2014 in Hong Kong and Dongguan. It is also the fourth of the Made in PRD report series published by the FHKI, serving as an important reference for Hong Kong s industrial development. In the 80s and 90s, manufacturing in the PRD region brought enormous development opportunities to Hong Kong enterprises, taking off Hong Kong s industries and contributing to the whole economy. The Guangdong-Hong Kong Front Shop, Back Factory operation mode was also formed at that time. Since 2006, however, the business operation environment in the PRD has experienced gradual changes shortage of Mainland labour and land resources and policy adjustments in various industries, import and export, labour, and exchange rate, etc. Meanwhile, the 2008 world financial crisis further gave Hong Kong enterprises a hard impact. Some of them could not adapt to the changes and had to relocate or close their businesses, resulting in a decrease in the number of Hong Kong factories operating in the PRD region in recent years. Those still in operation have to adjust their business strategies by adopting various changes, for instance, adding automated facilities, tapping into the domestic market, creating their own brands, setting aside more resources for R&D and design, as well as relocation to overseas. Having said the above, prolonged operation of Hong Kong manufacturers in the PRD has also resulted in the hollowing out of industries in Hong Kong, which has indirectly created a serious talent gap. The succession problem in the industrial sector also limits the sustainable development of our industries.

5 During my term as the FHKI Chairman from 2013 to 2015, all the General Committee and I rendered our full support to encourage enterprises in the PRD region to leverage on Hong Kong s advantages. Being an international city with a mutual commercial relationship with the Mainland should enable Hong Kong industries to develop new business opportunities as well as to transform and upgrade themselves. Such will continue to be the work of the FHKI. The development of Hong Kong industries needs the support from substantial government policies. Without this, Hong Kong enterprises are bound to encounter difficulties in their transformation and upgrading process. This report suggests that the Mainland Government should strengthen its co-ordination efforts with enterprises in policy consultation in order to enhance the business environment and manufacturing conditions in the PRD region. The SAR Government is also advised to initiate more co-operation with the Guangdong Provincial Government to improve the manufacturing situations and conditions in the PRD region. Currently, Hong Kong industries have entered into an era of re-positioning and image-rebuilding. Their key role in promoting long-term development of the overall economy and society must be recognised by the SAR Government which should establish a comprehensive industrial policy without delay. I sincerely hope this research report can receive active responses from both the Guangdong and Hong Kong Governments, industrial and business sectors as well as other stakeholders. Stanley Lau Honorary President, Federation of Hong Kong Industries October 2015

6 Preface HONG KONG INDUSTRIES AND MADE IN PEARL RIVER DELTA Hong Kong s Industrial Development Hong Kong s industrial development began at the end of the 19 th century with British investment in sugar and shipbuilding and Chinese investment in the production of matches, soap, and other products. Before the 1950s, Hong Kong s manufacturing mainly served the local market and sold goods to China and Southeast Asian countries; it also used the British Empire s Ottawa Agreement to promote international trade. The scale of Hong Kong s manufacturing was small and its impact on the local economy s development was not so evident. 1 The first breakthrough for Hong Kong s industrial sector came after World War II. A large number of Mainland entrepreneurs and refugees moved to Hong Kong and set up a manufacturing system its mainstay being light industries and labour-intensive processing trade. From 1950 to the mid-1980s, development peaked for the local manufacturing industry. It was the leading component of Hong Kong s GDP until 1988, representing over 20 per cent. 2 The manufacturing sector employed a large portion of the local population, increasing from 47,000 in 1947 to a peak of 905,000 in 1984, which was 41.7 per cent of the city s workforce at that time. 3 From 1950s to the 1970s, the western world imposed a trade boycott on China: very 1 莊重文, 香港工業之成長, 香港 : 三聯書店香港分店,1986 年, 第 5 頁 The Economist Intelligence Unit, Industry in Hong Kong, Hong Kong: South China Morning Post, 1962, pp.1. 2 Industry Department of Hong Kong Government, 1996 Hong Kong s Manufacturing Industries, pp. 8. 3 Census & Statistics Department, Hong Kong Statistics 1947-1967. Census & Statistics Department, Hong Kong Annual Digest of Statistics 1986. limited import and export to the Mainland greatly weakened Hong Kong s role as an international entrepôt. Manufacturers subsequently threw all their efforts into developing the European and American markets, which became the largest export markets for Hong Kong s manufactured goods. Hong Kong officially entered the world market where it remains today. At the close of the 1970s, Hong Kong s industrial development faced a challenge: the rate of increase in the export of manufactured goods declined. The colonial government set up the Advisory Committee on Diversification, and in 1979, it presented its report. Analysing the constraints on the city s industrial development, it recommended policies to promote industrial diversification, including adjustments in the use of industrial land, development of finance and education, industrial support, trade promotion, and external trade-related negotiations. This report also briefly mentioned the start of Hong Kong manufacturers investment in processing trade in Shenzhen. It recommended that the Government pays close attention to the development of the Pearl River Delta (PRD) and, at the appropriate time, improves co-operation between Guangdong and Hong Kong. This was the first mention in an official report suggesting that Hong Kong s manufacturing industry should consider linking with the PRD. Recommendation of this report was not implemented. Hong Kong was then entering a transition period before the return to China, and the new position of Hong Kong s industrial system was not a priority of the Government. More importantly, after China s open-door policy was introduced, every level of the Guangdong Government was providing all kinds of preferential concessions to encourage Hong Kong manufacturers to invest in and transfer their manufacturing to the PRD. This brought about the second breakthrough in Hong Kong s industrial sector, not as a result of internal policy changes but from external factors. If the first breakthrough was to develop external markets, then the second was to extend the manufacturing base from Hong Kong into the PRD.

7 The first breakthrough, from the 1950s to the 1960s, was due to industrialists coming from the outside (especially from Shanghai) investing in manufacturing in Hong Kong, creating the industrial base of Made in Hong Kong with Europe and the US being the major markets. Conversely, the second breakthrough, from the 1980s to the 1990s, was the expansion of investments of Hong Kong industrialists to the outside world. Hong Kong manufacturers set up factories in the PRD and promoted a change from Made in Hong Kong to Made by Hong Kong. This resulted in explosive growth for Hong Kong industry from 1980 to 2000. Hong Kong Industrialists and Made in PRD From the perspective of Hong Kong industries, Made by Hong Kong and Made in PRD were like a single operation. It involved the manufacturing relocation of Hong Kong industrialists, as well as the expansion of their investment to the PRD. For Hong Kong s overall economic development, it was a spatial expansion for its services, especially its producer service networks. Its economic hinterland increased from the 1,000 square kilometres of Hong Kong to the 40,000 square kilometres of the PRD. This formed the cornerstone of Guangdong- Hong Kong co-operation. This promoted the cooperation and division of labour between the PRD s manufacturing system and Hong Kong s service system, creating the distinctive Front Shop, Back Factory co-operation between Guangdong and Hong Kong. Hong Kong manufacturers made a key contribution to the Front Shop, Back Factory model. They invested in factories in the PRD and simultaneously promoted their Hong Kong offices into corporate headquarters the latter being responsible for overall market operations, financing, logistics, as well as research and development. Even more importantly, Hong Kong manufacturers worked closely with Hong Kong financial and logistics providers, transferring the PRD s manufacturing benefits to the Hong Kong service system. This promoted the city s economy at the end of the century to have an advanced service structure. Without the aid of the Back Factory in the PRD, the Front Shop in Hong Kong could not have expanded, and Hong Kong s economic takeoff at the end of the century would not have been possible. The Change of Made in PRD By the start of the new century, Hong Kong manufacturers had completed the relocation of production to the PRD. With manufacturers from Hong Kong, Taiwan, foreign countries, and the Mainland working together, the PRD built a relatively comprehensive manufacturing system, and became the most important export production base of China as the Factory of the World. From 2000 to 2008, Hong Kong manufacturers in the PRD continued to expand but also faced growing challenges. Traditional industries were the first hit: although their industrial value continued to increase, their share of the PRD s total industrial output started to fall. This was due to the takeoff in production of IT and electronic products by Taiwan-invested firms, the clustering of Japanese auto factories in Guangzhou, and breakthroughs by Mainland companies in telecom equipment, petrochemicals, and domestic electrical appliances.

8 In addition, in 2001, China entered the World Trade Organisation (WTO), resulting in a more regulated management system of imports, exports and bonded goods. Also, the PRD extensively developed container ports, enabling manufacturers to export and import goods directly or to sell locally, thereby they no longer need to make transshipments via Hong Kong. PRD-Hong Kong ties began to weaken, leading to a decline of influence of Hong Kong production service providers in the PRD. In 2006, China s 11 th Five-Year Plan was released. It brought a series of policy changes from the Central Government to local levels, in industrial strategies, foreign trade, labour and finance. These included the Central Government s export tax rebate policy changes, the promulgation of the Catalogue for the Guidance of Foreign Investment Industries, the reform of the renminbi exchange rate, the promulgation of the Labour Contract Law, and policies on industrial relocation, the unification of corporate income tax and environmental protection. There was also the Guangdong s provincial policy of emptying the cage for new birds for industrial relocation and upgrading in the PRD. The business environment of PRD manufacturing changed frequently and substantially. The shortage of migrant workers in the PRD influenced the recruitment of labour-intensive industries. In 2008, the Labour Contract Law led to sharp increases in labour costs. As a result, export factories in the PRD began to plan moving out their manufacturing operations; they transferred some of their PRD manufacturing activities to the Mainland s interior provinces where there was an abundance of large cheap labour supply. Some even left the Mainland and relocated their manufacturing to Southeast Asia. The PRD power systems could not meet the rising demand of industries; this also drove some manufacturers to move energyintensive operations out of the PRD. Hong Kong manufacturers began to lose interest in investing in the delta. Made in PRD after the Financial Crisis The global financial crisis of in 2008 caused export markets to shrink; this badly hit Hong Kong manufacturers, who were export-oriented. Those who built up their market base during the first industrial breakthrough were most affected. And for those who established their manufacturing base in the PRD during the second industrial breakthrough, they found it difficult to fit into the new industrial strategies stipulated in the 12 th Five-Year Plan. The Plan called for the development of strategic emerging industries and modern services. Hong Kong manufacturers faced mounting pressure to develop new markets externally and adjust their operations internally. They also needed to respond to demands to upgrade from local PRD governments. After relocating Hong Kong manufacturing to the PRD, there was a hollowing out of industries in Hong Kong itself. Manufacturing accounted for a record 24.3 per cent of the city s GDP in 1984; by 2000, it had fallen to 4.8 per cent and, by 2013, to 1.4 per cent. The number of employees in manufacturing fell from 333,700 in 2000 (accounting for 10.5 per cent of Hong Kong s total workforce) to 125,700 in 2013 (3.4 per cent of the total). The direct contribution of manufacturing to Hong Kong economy apparently was not significant, despite the fact that Hong Kong manufacturers created a processing trade volume of more than HK$one trillion, stimulating enormous development in commerce, trading, and logistics. The development of industries was unable to garner significant attention from the Government or from society. This affected the Government s allocation of resources toward industries and the interest of young people in joining the sector. So, when Hong Kong industries strived to upgrade and transform in the aftermath of the financial crisis, it lacked support resources from the city and from talented personnel. There was not sufficient vigour to move ahead.

9 Today, Hong Kong industries are again standing at the crossroads of manufacturing transformation. It is reconsidering the relations between the Hong Kong manufacturers and the manufacturing in PRD, the role of industries in Hong Kong s economic development, and the city s industrial future in the post-prd manufacturing era. INTRODUCING THE STUDY This research study was developed on the basis of a report published in April 2007 by the Hong Kong Federation of Industries entitled Made in PRD Challenges & Opportunities for HK Industry. This report studied the operations of Hong Kong-invested companies in the PRD, their sales features and R&D activities. It also assessed the business environment in the PRD. It was then the peak of Hong Kong manufacturers development in the delta, with booming exports. At the time, manufacturers could resolve challenges through adjusting their internal operations. They could also lobbied the Hong Kong and Guangdong governments to improve the business environment to resolve problems. The financial crisis of 2008 had an all-round and far-reaching impact on Hong Kong manufacturers. It severely affected their external market environment and changed the PRD manufacturing setting. It spurred Hong Kong industrialists into exploring the Mainland market and internet sales. Even more importantly, in the aftermath of this global financial crisis, almost all leading industrial countries sought new ways to develop manufacturing. There were initiatives such as the Industrie 4.0 in Germany, Advanced Manufacturing Partnership in the US, and the Mainland s Made in China 2025. Predictably, the Made in China 2025 initiative will have a major impact on both the Mainland and global industrial development. The future of Hong Kong industries should no longer be limited to using cheap labour and land resources on the Mainland; it is more important to maintain the link with the Mainland s industrial system and that of the world. Hong Kong industries and PRD manufacturing need to interact with each other; the PRD is a platform for Hong Kong to link up with the Made in China 2025 plan. In the post-prd manufacturing era, Hong Kong will reinvent itself with its industrial resources, responding to the new trends of Internet Plus, smart manufacturing, internationalisation, and will transform and expand in the global and Chinese industrial system. This is the springboard of the third breakthrough for Hong Kong industries. Aiming to promote the development of Hong Kong industries, this research study has employed questionnaire surveys, focus group meetings and, in-depth interviews to collect information and date. Literature review. has also been undertaken. 4 First, this report reviews changes in the operations of Hong Kong manufacturers in the PRD since 2008 and their progress in upgrading and transformation. It seeks to clarify what manufacturers expect from the Hong Kong Government in terms of strengthening industrial development, and also what they expect from governments in the PRD for improving the business environment. Through exchanges with stakeholders of the Hong Kong industries, the report seeks to understand the developmental directions of the industries support system. It compares key industrial development strategies in Europe, North America, and Japan and explores the Made in China 2025 initiative. It then makes comprehensive recommendations for the development of Hong Kong industry to rebuild its industrial competitiveness. 4 This survey, carried out from March to December in 2014, targets at Hong Konginvested manufacturers and received a total of 641 valid questionnaires. Focus group meetings and in-depth interviews covered manufacturers, industry stakeholders (such as producer service providers, scientific research organisations, Government departments, specialists and scholars). A total 10 focus group meetings and more than 20 interviews were arranged, which involved exchanges with more than 80 manufacturers and industry people.

10 CHAPTER 1 THE TRANSFORMATION OF MANUFACTURING IN THE PEARL RIVER DELTA Since the start of the reform and open-door policy in 1978, industry has been the most important sector propelling Guangdong s economic development. The eastern region of the Pearl River Delta (PRD) has established a manufacturing cluster with processing trade as its mainstay, thanks to exports from Hong Kong, Taiwan, and overseas firms. The western region of the PRD has been oriented more toward the domestic market, with a manufacturing cluster producing electrical appliances, automobiles, and household products. Industries contribution to Guangdong s GDP has been growing very rapidly, in terms of both the province s total output and its percentage share. Provincial industrial output increased from nine billion RMB in 1980 to 2.7426 trillion RMB in 2013, an average annual increase of 18.7 per cent. Industries share in the provincial GDP increased from 36 per cent in 1980 to a peak of 47.1 per cent in 2006. (See Figure 1.1) Figure 1.1: Guangdong s Industrial Development (1980 2013) Industrial Output (100 million RMB) 30,000 25,000 20,000 15,000 10,000 5,000 0 1980 1985 1990 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012 2013 Guangdong s Industrial Output Share of Industries in Guangdong s GDP (%) Source: Guangdong Statistical Yearbook 2014 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Share of Guangdong s GDP (%) The three main forces of Made in PRD have been the market expansion of PRD manufacturers, the support of local governments, and improvements in the delta s business environment; the resulting growth has been enormous and has brought about upgrades and transformation. The market is the base of the PRD manufacturing sector driving the expansion of its regional production network. Industrial policy has changed the structure and technology content of PRD manufacturing, pushing industrial upgrading and structural transformation. The PRD s macro business environment attracts foreign investments, develops new domestic enterprises, supports existing firms, phases out backward ones, and regulates business practices. Since 2000, and especially after 2008, great changes have occurred in the PRD with regards to market orientation, industrial policy, and business environment. These changes are due to external market factors beyond control as well as internal policy changes driven by the Mainland Government. These changes are pushing the PRD industrial system to transform and upgrade itself, advance the technological level of industrial products, and automate manufacturing. Subsequently, some traditional industries have had to move elsewhere, downsize, or close. It has been and continues to be a period of great changes in the PRD. For Hong Kong manufacturers, it is a transition period in which only the fittest will survive.

11 CHANGE IN MARKET DIRECTION OF MANUFACTURING IN THE PRD Prior to the 1980s, Guangdong only accounted for four to five per cent of national industrial output. Its industries were weak because it lacked mineral resources and had few state-owned firms; its industries ranking was among the lowest in the nation. The open-door policy brought an infusion of outside investment more importantly, it opened up the international market. From 1980 to 2000, the income of Mainland residents was not high and their purchasing power was low; therefore, the scale of the domestic market was small. As the eastern region of the PRD adopted the exportprocessing model producing labour-intensive goods such as textiles and garments, leather cases and bags, and electrical appliances companies aggressively developed the international market. The western region of the PRD operated on an import-substitution strategy, producing in-demand electrical appliances and selling the Guangdongmade products nationwide. Both eastern and western regions of the PRD each had their own market priorities; thus, the characteristics of their products were differentiated. Companies on the east were mainly established with investments from Hong Kong, Taiwan, and foreign firms, while collective and private companies congregated on the west. Together, manufacturing clusters catering both to the export market and to domestic consumption have been built over the 40,000-plus square kilometres of the PRD. The period from 1980 to 2000 was one of major development in globalisation. The international trading system benefitted from the end of the Cold War, the establishment of the WTO trading regulations, as well as the liberalisation of the global market. Driven by the market boom in the United States, the scale of the international market grew very rapidly. With Hong Kong facilitating as an intermediary for re-exports, PRD goods quickly entered the international market. China s accession to the WTO in 2001 reduced the possibility that developed countries might use political means and impose trade sanctions on Chinese goods. With this new integration into the world economy, exports from the PRD further soared. In 2005, Guangdong s industrial exports accounted for 40.9 per cent of the province s total sales, and the structure of exports improved evidently, beginning with the export of IT and technological products with more high-tech content. 5 The 2008 financial crisis marked a watershed for manufacturing in the PRD, causing a major downturn or even shrinking in export markets. To counter the global recession, the Mainland Government adopted many policies to stimulate consumption, including subsidising electrical appliance purchases in rural areas and automobile purchases. This stimulated growthin Guangdong s auto sector and Shunde s appliance sector appliance from 2009 to 2011. 5 Guangdong Provincial Statistics Bureau, 24 January 2008, http://www.gdstats.gov.cn/tjzl/ tjkx/200801/t20080124_52500.html.

12 Table 1.1: Sales of Guangdong s industrial enterprises above Designated Size (2000-2013) 2000 2005 2010 2011 2012 2013 Value of Industrial Sales (billion RMB) 1,215.6 3,504.6 8,364.7 9,262.5 9,375.4 10,685.4 Value of Export Shipments (billion RMB) 463.4 1,432.7 2,591.9 2,740.8 2,854.1 3,020.5 Proportion of exports in total sales 38.1% 40.9% 31.0% 29.6% 30.4% 28.3% Sources: Guangdong Statistical Yearbook 2012 and 2014 Thus, the domestic market continued to grow while exports became less important. The proportion of exports of Guangdong s industrial enterprises above Designated Size 6 fell continuously, to 28.3 per cent by 2013, and the influence of exporting factories in Guangdong s industrial system quickly weakened. (See Table 1.1) Guangdong s total retail consumer sales continued to grow, maintaining double-digit growth; this underscored the opportunities in the Mainland market. After the financial crisis, the total volume of imports and exports fluctuated with great volatility, falling by as much as 10.6 per cent. Starting in 2012, growth vacillated between 1.3 and 10.7 per cent. The proportion of international trade volume in total consumer sales fell from 467 per cent in 2006 to 266 per cent in 2013. (See Figure 1.2) 6 In 1998, the State Statistical Bureau divided its industrial statistics into two parts: industrial enterprises above Designated Size, and enterprises below Designated Size. Industrial enterprises above Designated Size were defined, from 1998 to 2006, as all stateowned companies, and non-state-owned enterprises with an annual revenue of more than five million RMB from their principal business. From 2007 to 2010, this definition was industrial enterprises with an annual revenue of more than five million RMB from their principal business. Since 2011, the revenue amount has been raised to more than 20 million RMB for these firms. The sales boom on the Mainland prompted export manufacturers in the PRD to explore opportunities in the domestic market; they hoped to find a new source of growth outside the weakening export market. The Guangdong Government utilised numerous fiscal resources to promote Guangdong products all over the country. The objective was to stimulate consumption, expand domestic demand, modify the structure, and stabilise growth. One example was the introduction of the Buy Guangdong Goods Online campaign in line with the boom of online purchasing. In 2012, the Hong Kong SAR Government introduced a HK$ one billion fund, Dedicated Fund on Branding, Upgrading and Domestic Sales (BUD Fund), to help Hong Kong companies sell in the Mainland. Figure 1.2: Comparison of Guangdong s International Trade with its total Consumer Retail Sales (2000 2013) Value (100 million RMB) 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 International Trade Value Total Retail Sales of Consumer Goods Ratio of International Trade to Total Retail Sales Source: Guangdong Statistical Yearbook, various issues. 500% 450% 400% 350% 300% 250% 200% 150% 100% 50% 0% Ratio of International Trade to Total Retail Sales

13 For many years, the marketisation level of Guangdong s economy has been higher than that of other provinces and cities; this can be attributed partly to the PRD s export-oriented model. Exporting manufacturers in the PRD have been conducting international trade which requires their operational methods to comply with global economic and trading practices; the management of these companies has also been standardised. The primary markets for PRD manufacturers are changing, and different markets have different rules of operation; this has led manufacturing enterprises as well as the overall industrial structure to change accordingly. The 2008 financial crisis shifted the market s centre of gravity and put enormous pressure on export manufacturers on the PRD s eastern side. Manufacturers in Guangzhou and on the western side still had the competitive advantage of selling to the domestic market. This shifted the manufacturing balance between the eastern and western regions, with Hong Kong manufacturers on the eastern side being more greatly affected. CHANGES IN MANUFACTURING STRUCTURE IN THE PRD The development of Guangdong industries has been closely related to its industrial policy. At the end of the 20 th century, industries in the PRD applied the model of attracting investment from Hong Kong, Taiwan, and foreign enterprises; within a short period of 20 years, it subsequently built a manufacturing base and a comprehensive industrial supply system. From the 10 th to the 11 th Five-Year Plan After 2000, there were major changes in Guangdong s industrial strategy; this not only spurred the rate of industrial growth, more importantly, it modified the structure of industry. Guangdong s 10 th Five-Year Plan (2001 2005) presented a trio of traditional, new, and potential industries. The province s 11 th Five-Year Plan (2006 2010) promoted the development of nine major industries. Of these, electronics and telecom, electrical machinery and specialised equipment, as well as oil and petrochemicals were the three new industries; textiles and garments, food and beverage, and construction materials the three traditional industries; and automobiles, pulp and paper-making, and pharmaceuticals the three potential industries.

14 Table 1.2: Industrial Added-Value of Guangdong s Nine Major Industries (2005-2010) Value-Added of Industrial Enterprises above Designated Size Value-Added of Industry (billion RMB) 2005 2010 Annual Growth (%) 2005 2010 941.6 2,298.8 19.5% Value-Added of Nine Major Industries 683.3 1,600.2 18.6% Three Emerging Industries 462.4 1,005.3 16.8% Electronic and Information Technology 209.5 430.6 15.5% Electric Equipment and Special-Purpose Machinery 132.2 312.0 18.7% Petroleum and Chemistry 120.7 262.7 16.8% Three Traditional Industries 150.0 380.9 20.5% Textile and Garments 57.2 147.5 20.8% Food and Beverage 56.0 123.6 17.1% Building Materials 36.7 109.8 24.5% Three High-Potential Industries 71.0 214.0 24.7% Logging and Papermaking 21.1 55.0 21.2% Medicine 11.4 27.9 19.7% Automobiles and Motor Vehicles 38.5 131.1 27.8% Source: Guangdong Provincial Statistical Yearbook 2006, 2011 The 2008 financial crisis badly affected the exportoriented electronics and IT sector. However, led by sales of the traditional industries of textiles, garments, and construction materials, the highpotential sectors of automobiles and motorcycles did quite well. Guangdong Province therefore again changed its industrial development outlook in its 12 th Five-Year Plan. (See Table 1.2) 12 th Five-Year Plan Guangdong Province s 12 th Five-Year Plan proposed a modernised industrial system and development of strategic new industries and advanced manufacturing. It included high-end electronics and 7 Guangdong Provincial Statistics Bureau, 23 Jaunary 2015, http://www.gdstats.gov.cn/tjzl/ tjkx/201501/t20150123_196150.html IT products, energy-efficient cars, semiconductor lighting, energy-saving and environmental protection, solar photovoltaics, nuclear power equipment, wind power, biotechnology, new materials, aviation, aeronautics, and marine development. By 2015, Guangdong expects the production scale of these strategic new industries to exceed two trillion RMB, with advanced manufacturing and high-technology manufacturing accounting for 50 per cent and 26 per cent, respectively, of the industrial added-value of enterprises above the Designated Size. In 2014, Guangdong s advanced manufacturing and high-technology manufacturing accounted for 48.1 per cent and 25.7 per cent, respectively, of industrial added-value above Designated Size. 7 The province s electronics and telecommunications equipment production (part of high-technology manufacturing), benefitted from the development of smart phones and grew by an annual average of 22.6 per cent from 2011 to 2013, having the fastest growth of any industrial sector. (See Table 1.3)

15 Table 1.3: Industrial Added-value of Advanced and High-Technology Manufacturing in Guangdong (2011 2013) Industrial Added-value (billion yuen) 2011 2013 2011 2013 Annual Growth Industrial Added-value of Enterprises above Designated Size 2,166.3 2654.0 10.7% Advanced Manufacturing Industry 1,032.6 1,271.5 11.0% Equipment Manufacturing 732.5 944.8 13.6% Steel and Iron Processing 39.5 41.6 2.7% Petroleum and Chemical Industry 260.7 285.0 4.6% High-Technology Industry 474.1 665.4 18.5% Information and Chemical Products 2.4 3.0 10.6% Medicine 28.7 38.5 15.7% Aircraft and Spacecraft Industry 1.9 2.5 16.2% Electronic and Communication Equipment 341.5 513.0 22.6% Computers and Office Equipment 84.0 85.8 1.0% Medical Equipment, Instruments, and Metres 15.6 22.7 20.8% Source: Guangdong Statistical Yearbook 2012, 2014 Table 1.4: Industrial Added-value of Advanced, High-technology Manufacturing of PRD Cities (2013) Industrial Added-value (billion RMB) Advanced Manufacturing High-technology Manufacturing Share of Local Industrial Added-value Advanced Manufacturing High-technology Manufacturing Guangdong 1,271.5 665.4 47.9% 25.1% Pearl River Delta 1,116.3 631.0 52.0% 29.4% Shenzhen 413.5 349.2 71.4% 60.3% Guangzhou 244.9 53.2 55.1% 12.0% Foshan 125.4 28.3 32.4% 7.3% Dongguan 112.0 86.4 46.2% 35.6% Huizhou 94.4 59.5 66.3% 41.8% Zhongshan 41.4 19.5 34.6% 16.3% Zhuhai 35.8 22.0 45.7% 28.1% Zhaoqing 27.0 8.1 33.4% 10.1% Jiangmen 21.9 4.8 31.4% 6.8% Source: Guangdong Statistical Yearbook 2014 In 2013, nine cities of the PRD met their respective development targets set by Guangdong. Shenzhen ranked first: the city s advanced manufacturing and high-technology manufacturing accounted for 71.4 per cent and 60.3 per cent, respectively, of the city s industrial added-value. Shenzhen also completed upgrading its industrial technology: its enterprise composition transformed from one dominated by foreign-invested firms to that of domestic private hitech companies, establishing a new structure under which domestic and foreign companies developed together. (See Table 1.4)

16 Table 1.5: Added-value of Guangdong s Industrial Enterprises above Designated Size (2000 2013) By Industry 2000 2005 2010 2012 2013 Light industry 47.6% 41.8% 39.5% 39.3% 38.9% Heavy industry 52.4% 58.2% 60.5% 60.7% 61.1% By Ownership Foreign, Hong Kong, Macau, and Taiwan Investment 54.5% 63.1% 52.1% 48.4% 46.2% Foreign-invested enterprises 16.8% 28.2% 25.6% 23.7% 23.1% Hong Kong-, Macau-, and Taiwaninvested enterprises 37.7% 34.9% 26.5% 24.7% 23.1% Source: Guangdong Statistical Yearbook 2014 Over the past decade, Guangdong s industrial structure has transformed due to changes in its industrial policy. In 2000, the respective shares of light and heavy industry in total industrial output were about the same. Since then, driven by projects in petrochemicals, iron and steel, automobiles, and nuclear energy, the proportion of heavy industry has gradually increased. Conversely, the proportion of Guangdong s industrial added-value contributed by foreign-, Hong Kong-, Macau-, and Taiwan-invested companies has fallen from over 50 per cent in 2000 to less than 50 per cent today, with those of Hong Kong, Macau, and Taiwan falling the fastest. In 2013, the proportion of their industrial addedvalue was less than 25 per cent of the province s total. (See Table 1.5) Since 2000, Guangdong s industrial policy has basically enabled the PRD to transform its industrial structure. It has evolved from a model driven by foreign, Hong Kong, and Taiwan investment to one in which domestic and foreign companies are balanced. t has also switched from a model based on labour-intensive manufacturing to a technologyintensive one producing equipment. However, close attention should be paid to the fact that the links between Hong Kong and PRD manufacturing have declined quickly. One reason for this decline is the decreasing number of Hong Kong companies in the PRD manufacturing system. More important is the lack of progress in technological development, making it difficult to expand scale of production, so manufacturing operations can only respond passively to new circumstances. DEVELOPMENT OF PRD BUSINESS POLICIES Changes in Policy Direction The PRD s system of business policies started to change in 2006 following the 11 th Five-Year Plan (2006 2010). Post financial crisis, during the 12 th Five-Year Plan (2011 2015), it made more adjustments. The business policies brought many challenges to Hong Kong manufacturing in the PRD and affected the collaboration between Hong Kong industries and PRD manufacturing. Domestic demand and foreign trade being equally important, When the Central Government drew up the 11 th Five-Year Plan, it adopted the principle of transformation to guide its economic policies. First, it changed the development model from one of over-reliance on export markets to one in which domestic demand and the international market could develop together.

17 Second, it aimed to slow the enormous rise in foreign exchange reserves (which had reached US$818.9 billion by 2005) caused by surpluses in merchandise trade. It also set out to reduce the number of anti-dumping sanctions against China s exports brought by the international community. The plan called for long-term trade balance. The Central Government chose the sector of processing trade, which had large trade surpluses, as a priority for reform; it hopes this would bring the foreign reserves to a reasonable level. Strengthening the rights of workers: The 11 th Five-Year Plan covered the period when the Mainland was at a crossroads, with its population dividend diminishing. After the rural reforms of 1979, huge numbers of young farmers moved from the villages to work in manufacturing in the cities. By 2000, they were entering middle age. In the 1980s, the Mainland implemented the one-child policy, and by 2000, its consequences were becoming clear as the number of young people had fallen quickly. Additionally, in 1999, the Mainland began increasing recruitment of college students in a bid to raise the educational level of the youth. Young people with higher education, however, preferred to work in the service sector, which indirectly suppressed growth of the migrant labour force. A shortage of migrant workers first hit the PRD s manufacturing system in 2003; then the shortages occurred more frequently, eventually becoming a fact of life. These labour shortages caused a shift in the balance of power between employers and employees, with the bargaining advantage favouring the latter. This prompted the Mainland Government to introduce gradually, in 2006, labour-related laws and regulations to strengthen the rights and improve the livelihood of workers. Changing the processing trade in the PRD: The Yangtze and Pearl River Deltas historically have been the two large regions for processing trade. The Yangtze Delta supported concentrations of large-scale Taiwan factories producing notebook computers, IT, and electronics products. Taiwan started investing in the Mainland after 2002, producing goods with a high technological level. Their factories belonged to the high-tech sector, and their operations conformed to standard business practices. The PRD supported a concentration of traditional and labour-intensive industries, most of which had invested in the Mainland between 1980 and 2000, with a low technology level. The majority of these firms were small- and medium-sized companies who often did not meet regular business standards. The PRD therefore became a priority reform area for processing trade, with most related reform measures first being introduced there. This had an enormous impact on export-oriented processing factories in the PRD: it promoted transformation but also suppressed changes in some cases. The PRD strengthens the service sector: The financial crisis continued to affect exports from the PRD. After the four trillion RMB stimulation of consumption, domestic demand resumed its normal growth. Growth of international and domestic consumption subsequently slowed, which was not conducive to manufacturing expansion. Added to the long-standing difficulties of the PRD s labour shortage, Guangdong was unable to fulfill targets set in the 11 th Five-Year Plan, especially in the nine big sectors. In its 12 th Five-Year Plan, the province proposed the development of a modern industrial system with special emphasis on a modern service sector. Manufacturing sectors other than strategic new industries found it hard to attract policy support; sometimes they even had to shoulder the pressure screated by these policies.

18 Government Restricts Processing Trade The Mainland s trade processing policy aimed at providing export tax rebates for intermediate domestic inputs and materials. It implemented bonded supervision for imported intermediate inputs and materials in order to encourage the export of products. Bonded supervision uses two systems, a customs duty deposit system and a deep processing transfer system, to charge customs duty on processing materials imported by the processing company. Depending on the nature of the company, a nominal payment ( 空轉 ), or a 50 per cent deposit, or actual payments( 實轉 )would be applied. This nominal payment system involved no actual payment but provided great convenience in terms of capital management to trade processing firms. The Mainland Government concentrated its changes in policy in three main respects: 1. Changing the export tax rebate: The Mainland changed the rebate rates to encourage labourintensive processing firms to transform and upgrade. In September 2006, Mainland ministries issued two documents, one being The Circular on Adjustments Made to the Export VAT Rebate Rates for Certain Products and the Expansion of the Prohibited Category under Processing Trade (Finance and Tax [2006], Circular No.139); the other being A Supplementary Circular on Adjustments Made to the Export VAT Rebate Rates for Certain Products (Finance and Tax [2006], Circular No.145). They abolished or reduced export tax rebates for labour-intensive products as well as the so-called two high, one resource industries referring to production processes with highenergy consumption, high levels of pollution, and that over-used resources. 8 Beijing, Tianjin, Shanghai, Liaoning, Hebei, Shandong, Jiangsu, Zhejiang, Fujian, Guangdong. The Central Government cut export tax rebates to regulate the scale of the processing trade and to encourage such firms to use surplus goods produced by domestic firms, such as iron and steel raw materials. After the 2008 financial crisis, the Government temporarily increased the rate of the export tax rebate to maintain stability of the export industry. 2. Making adjustment to the commodities list for processing trade: In 2007, the General Administration of Customs, the Ministry of Commerce, and other departments greatly expanded the list of goods that were prohibited or restricted in processing trade. Processing firms could not use the bonded approach to import products on the prohibited list nor could they apply for export tax rebates. With restricted items, manufacturers had to provide a bankguaranteed customs duty deposit for actual payments. This put pressure on company s cash flow. The main goods added to the restriction list in 2007 were related to plastics, textiles, furniture, crude processing of metals, and other labour-intensive items, making operations in traditional sectors more difficult. 3. Encouraging industrial relocate to central and western regions: According to customs classification of processing firms, Category A and B companies in the eastern region 8 had to pay 50 per cent of the tariff and VAT on the import of restricted commodities, as a customs duty deposit. Firms in these categories in the central and western regions, however, were entitled to the benefit of nominal payment under the bank guarantee scheme. Many Hong Kong and Taiwan processing firms were in the B category. The Government used this regional difference in customs duty to encourage them to relocate to central and western regions.