What Is Hong Kong SAR, China? Importance in Finance

What Is Hong Kong SAR, China?

Hong Kong is the premier financial and business center in China and a regional financial leader. Hong Kong is one of China's special administrative regions (SARs). A SAR is a relatively autonomous region within the People's Republic of China that maintains separate legal, administrative, and judicial systems from the rest of the country.

Understanding Hong Kong SAR, China

Hong Kong is a special administrative region (SAR) that exists as part of the People’s Republic of China under the “One Country, Two Systems” doctrine, negotiated in the Sino-British Joint Declaration, negotiated and signed in 1984, but taking effect in 1997.

The "One Country, Two Systems" doctrine stipulated that the People's Republic of China's socialist system would not be practiced in Hong Kong, and Hong Kong would maintain its political and economic quasi-independence for 50 years after the transfer of sovereignty, until 2047.

What does that mean? Since July 1, 1997, when the United Kingdom transferred the sovereignty of Hong Kong to China, Hong Kong has maintained a separate political and economic system from China—democratic(ish), and capitalist—and a separate currency (the Hong Kong Dollar, HKD$).

Hong Kong retains independent executive, legislative, and judiciary powers, in all matters other than military defense and foreign affairs. English and Chinese are the two official languages.

Hong Kong's Economy

Hong Kong was ranked as the world's freest economy in the Heritage Foundation's Index of Economic Freedom from the index's inception in 1995, until 2020 when Singapore knocked it off the top spot to number two. However, the following year, in 2021, the index stopped including Hong Kong and Macau due to an increase in China's influence.

In 1990, Milton Friedman wrote that it was perhaps the best example of a free market economy. The service economy in Hong Kong is characterized primarily by low taxation, near-free port trade, and a well-established international financial market. Service economy, here, means an economy that is not industrial, or manufacturing based, but is instead based on financial services, health, and human services, hospitality, information technology, etc.

Using its political and economic autonomy, Hong Kong has positioned itself as the place where international and Chinese businesses find common ground. It is also considered the principal financial center in China. As a result, more than 9,000 companies in Hong Kong have parent companies located outside of Hong Kong in 2023.

This democratic government and the free market have been successful, to some extent. It's the world's 43rd largest economy in 2022 with a population smaller than the city of Tokyo, at 7.35 million in 2022. Hong Kong had a GDP of $359.8 billion in 2022, giving it the world's 28th highest GDP per capita, at $48,983 in 2022.

Hong Kong and China's Tensions

Historically, China has had considerable incentive to refrain from interfering in Hong Kong's political and economic systems. At the transfer of sovereignty in 1997, Hong Kong, with a population of 6.5 million at the time, had an economy one-fifth the size of the Chinese economy, which had a population of over 1.2 billion.

This is no longer the case. Over the past 20 years, Hong Kong's economy has stagnated, changing very little in makeup, with GDP growth slowing, and inequality rising significantly. During the same period, China became an economic superpower. As of 2022, Hong Kong now accounts for just 2% of Chinese GDP.

Some think that the greatest risk to Hong Kong's autonomy is political and business elites in the region ceding it to the Liaison Office, to remove political tensions from the region, and return Hong Kong to an economic city.

This may prove a poor decision though, as a marriage of business and government has proven counterproductive in Hong Kong, leading to an increase in conflicts of interest and cronyism, not to mention a non-responsive government that refuses to broaden its tax base or lower property taxes, and has excluded political parties from democratic participation. All of this has led to a public perception of the Hong Kong SAR government as not as legitimate as it once was.

Given these recent trends, the Liaison Office, the People's Republic of China representative in Hong Kong, has been taking steps to meaningfully increase its influence and clout in the region, interfering in both domestic affairs and elections.

For example, the Liaison Office bought Hong Kong's largest publishing house (removing titles critical of the Communist Party) and lobbied for Hong Kong's 2017 chief executive, Carrie Lam. In 2022, Lam stepped down.

The Bottom Line

Hong Kong is one of the leading financial centers in the world and for a large part of its history was under British rule, until it was "returned" to China in 1997. Hong Kong operated outside of China's sphere of politics for a long time after returning to the country; however, as China has grown, both in economic and political power, it has brought Hong Kong further into its control. The region continues to be a prominent financial hub in both Asia and the world.