What does the establishment of cross-straits links mean for the future of Hong Kong? The start last week of a limited number of direct flights between various mainland and Taiwan is as yet a minor issue. But the broader, longer-term challenges for Hong Kong could be substantial.

How much the territory suffers will depend not so much on what happens to the mainland but on how far Taipei will go to liberalize its economy now that direct links make it possible, at least in theory, for Taiwan to develop as a regional trade and finance hub. And it will depend on whether Hong Kong’s lackluster leadership can raise its sights beyond trying to please Beijing by integrating with the Pearl River delta and focus instead on capitalizing on its separate status and international links.

The Hong Kong Tourism Board has stated that direct air links could cost the territory HK$300 million (US$38.5 million) a year in loss of business from Taiwanese now using Hong Kong as a transit point. That is in fact not much. The transit traffic brings little revenue other than to Cathay Pacific Airways and the Airport Authority. Taiwan traffic accounts for about 14 percent of flights, of which perhaps half represent transit traffic.

Nor will all that disappear even when cross-straits flight frequencies and destinations are driven by demand rather than political negotiation. Many Taiwanese businesses are just across the border and they will continue to use Hong Kong as stepping stone. Gradual mainland access to Taiwan is not likely to mean that tourism to Hong Kong will suffer – Macau and its gambling dens is a bigger attraction.

The situation with shipping is less clear. At present Taiwan accounts for about 7 percent of China-bound container traffic transshipped in Hong Kong and Taiwan-China accounts for 9 percent of Hong Kong’s re-export trade, mostly of goods going to the mainland. The re-export business seems unlikely to be much affected as either it involves some re-processing or packaging in Hong Kong, or is simply re-invoiced and shipped out again for tax purposes, ensuring that profit stays in Hong Kong where tax is low and exchange controls non-existent.

The future of the transit trade is more complex but there were already holes in the ban on direct shipping links, notably the direct trade allowed to local vessels with Fujian ports. Much trade with central and northern China goes via Korea and Japan. Hong Kong is anyway in relative decline as a port due to competition from nearby Shenzhen ports which have lower charges and direct rail access.

Nonetheless not only will some of the transit trade go elsewhere but direct links would help revive Kaohsiung’s competitive position as a hub and taken business away from the south China container ports. (In an example of head-in-the-sand official attitudes in Hong Kong a recently published Port Cargo Forecast prepared for the Transport and Housing Bureau makes no mention of the potential impact of cross-strait shipping links.)

The bigger problem for Hong Kong probably lies not with sectors where its relative position is already in decline but the higher value-added service industries in which it still is well ahead. At the most basic level, it could lose some trade finance banking business which is currently routed through it. Barriers to Taiwan banks operating in the mainland have already begun to come down and Taiwan banks with affiliates in Hong Kong are eagerly looking for opportunities to grow in the mainland.

Another loss for Hong Kong could well be additional listings of the mainland operations of Taiwan businesses such as phone maker Foxconn. These have had to be made in Hong Kong because of the limits hitherto imposed on Taiwan companies’ mainland investments.

Hong Kong’s failure over the past few years to attract stocks other than mainland and Taiwan ones will be further shown up if listings here cease to be needed by Taiwan companies. Quite possibly too mainland investors, if given the chance, will focus more attention on Taiwan stocks and property at the expense of diversification into Hong Kong.

More broadly still is the threat that if Taiwan followed up directs links with liberalizing a whole range of activities it could begin to challenge Hong Kong as a regional center for doing business not only with China but the whole of northeast Asia. Taiwan has been held back not just by lack of cross-strait links but by restrictions on employing foreigners, many bureaucratic procedures, and the protection given to local service industries which has kept out more competitive foreign ones.

In other words Taiwan has failed to exploit its strengths: A strong currency, backed by huge reserves, few exchange controls (which could readily be abolished), an active capital market and large (if sluggish) banking and insurance sector. It is a natural IT hub, with close ties to the US West Coast as well as the mainland, and technical capabilities to be a service centre for industries including shipping, plastics, and production engineering. It has a lively cultural scene, relatively clean air and freedoms of speech and the media which now probably surpass those in Hong Kong. English language capability is weak but partly offset by Putonghua fluency compared with Hong Kong, and greater familiarity with Japanese.

In other words a Taiwan enjoying serviceable relations with the mainland but retaining complete control over its domestic and foreign trade and finance policies has the potential to rival Hong Kong in many ways. The more Hong Kong downplays its differences with the mainland, the more effort and money it puts into the Pearl River Delta relationship at the expense of its international role, the more its policies are driven either by Beijing or vested local interests using nationalism as a business tool, the worse the pollution becomes thanks to bureaucrats frightened of politically connected business interests, the greater the chances for Taiwan to supplant Hong Kong as a trading hub open to all.

Hong Kong Used to be Scared of Shanghai…

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