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Hong Kong’s independence from China has helped it to become a global financial and re-export hub and the gateway to trade between the Chinese market and the rest of the world. But recent questions over its autonomy have been raised by the US, fuelling more tension between the world’s two largest economies, with Hong Kong caught in the crossfire.

On May 28, Beijing imposed national security laws on Hong Kong, ignoring warnings from Washington which threatened to revoke Hong Kong’s special trade status if the legislation was passed. The following day, US President Donald Trump said his administration would begin the process of removing Hong Kong’s preferential treatment as well as sanction the lawmakers involved.

The National People’s Congress (NPC), which approved the security law, says the legislation “opposes the interference in the HKSAR [Hong Kong Special Administrative Region] affairs by any foreign or external forces in any form”, taking “necessary countermeasures” where appropriate.

US secretary of state Mike Pompeo had warned Beijing only one day earlier that if it passed the legislation it may revoke Hong Kong’s special status, which sees the US treat the region differently to China when it comes to trade and financial transactions. Elevated US tariffs imposed on China in the previous trade war don’t apply to Hong Kong, for example.

“No reasonable person can assert today that Hong Kong maintains a high degree of autonomy from China, given facts on the ground,” Pompeo said on May 27.

Chinese officials have since hit back. When US state department spokesperson Morgan Ortagus tweeted that the Chinese government had “flagrantly broken its promises to the people of Hong Kong” with its new law, Hua Chunying, a spokesperson for China’s foreign ministry, wrote in response: “I can’t breathe.” These were the final words spoken by George Floyd, the African-American man who was killed while being held by police officers in Minneapolis last week, triggering protests around the world.

While it is not entirely clear how the security legislation or the US’ process of revoking Hong Kong’s preferential treatment will take shape, the action follows months of civil protests in Hong Kong and a deteriorating relationship between China and the US over trade and Covid-19, with Trump recently making fresh tariff threats to China over the pandemic.

Under China’s “one country, two systems” policy, which was adopted following Britain handing back the region to China in 1997, the semi-autonomous state of Hong Kong has been able to maintain its position as a free port, attracting companies from around the world to establish regional hubs in the city. The region has its own open financial system, with a currency linked to the US dollar and no capital controls, which has helped it to become a global financial hub.

 

“Collateral damage”

“You have free mobility of capital, and there’s no restrictions on information and the legal system is different. If those things didn’t apply anymore, then it would be reasonable for the US to say that there’s no point having special trade status,” says Carlos Casanova, economist for Asia Pacific at Coface. “It’s fair to say that Hong Kong has been caught in the fire between the US and China in this bilateral trade war, that is now more than a trade war.”

He tells GTR that, in some sense, Hong Kong is “collateral damage”. “Hong Kong is caught in the middle, be it because of re-exports, or because it’s just another argument that can be used to exert pressure on China to prevent certain changes.”

Hong Kong acts as the gateway between mainland China and the US. While products from Hong Kong face significantly lower import tariffs in the US than goods from mainland China, most of the goods shipped to the US from Hong Kong originate in China, meaning they are subject to higher tariffs.

In 2018, Hong Kong’s domestic goods exports were valued at US$6bn, while re-exports totalled approximately US$530.5bn (figure 1), with the top two destinations of all re-exports being mainland China and the US.

Figure 1: Hong Kong domestic goods exports and re-exports value (US$bn)

Hong Kong trade may not be directly impacted by the removal of its special trade status because it is a re-export hub and is little affected by increased tariffs on domestic goods. However, as a re-export hub, it has been “massively” impacted since the start of the US-China trade war, as logistics firms and those involved in re-exporting have seen declining orders, says Casanova.

By removing Hong Kong’s special status, the US is risking retaliatory measures by China and tariffs on its exports to Hong Kong. US goods and services trade with Hong Kong totalled US$66.9bn in 2018, exports to Hong Kong were valued at US$50.1bn, while imports from the region stood much lower at US$16.8bn.

It could also harm the 1,300 US firms operating in the region. “Nearly every major US financial firm maintained a presence in Hong Kong, with hundreds of billions of dollars in assets under management,” says the US state department’s annual 2019 Hong Kong policy report.

US companies invest in Hong Kong because of its special status, its geographic location and market-based economic system. “Any change to this status quo would irreparably damage American global business interests,” says the US-China Business Council in a statement.