Non-institutional Economic Integration via Cultural Affinity

Economic integration among the Mainland, Taiwan and Hong Kong (the trio) has thrived despite the absence of institutional arrangements such as a trade bloc. Geographical and cultural proximity and the efficiency of Hong Kong as a "middleman" have enabled the trio to develop extremely intense trade and investment linkages despite the Mainland's strict controls on trade, investment and foreign exchange, and Taiwan's unwillingness to deal directly with the Mainland. To document the extent of economic integration among the trio, this paper combs through and compares the trade and investment statistics of the Mainland, Taiwan and Hong Kong, making careful adjustments for the re-export mark-up in Hong Kong's entrepot trade as well as differences in f.o.b. and c.i.f. prices. It is believed that the statistics presented give the most accurate picture so far of Mainland-Hong Kong trade, Mainland-Taiwan trade (including both indirect trade and the substantial but often ignored direct trade), Taiwan-Hong Kong trade and China's trade by country/region. Since the inauguration of China's open policy in 1979, China has established more and more direct links with the world, but an increasing fraction of China's trade is handled indirectly via Hong Kong. A theory of intermediation is developed to explain this paradox: the decentralization of China's trading system has greatly increased the number of potential trade links and raised the transaction cost of trade. The efficiency of Hong Kong as a "middleman" lowers the transaction cost of trade with China and promotes the integration of the trio. The theory predicts a bright prospect for Hong Kong as a "middleman" because a big trading centre tends to get bigger and even more efficient due to the economies of scale and economies of agglomeration in trade. Even if Taiwan should deal directly with the Mainland, Hong Kong's "middleman" activities would continue to thrive. Economic integration among the trio will thrive despite the absence of institutional arrangements. Proposals for institutional integration among the trio such as the formation of a trade bloc, or a "greater Hong Kong" arrangement involving Hong Kong and Shenzhen are utopian and counter-productive. Hong Kong must maintain border controls against Shenzhen and China. Otherwise, Hong Kong's GATT membership and clothing quotas will be jeopardized. The abolition of Shenzhen's border controls against Hong Kong would also pose similar complications for China. The present unilateral favouritism given by the Mainland to Taiwan is counterproductive. The best policy framework for integration of the trio is not the institution of discriminatory preferences but trade liberalization in the Mainland and in Taiwan and GATT membership for both. Consultation through the APEC, through semi-official or private forums can lower transaction costs through improved information flow and policy coordination.