## _wp08273

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### I. Introduction — Integration between Hong Kong SAR and the Mainland (PRD)
- Between 2001 and 2006, the stock of Hong Kong SAR’s outward FDI into the Mainland nearly tripled to US$270 billion and accounted for almost 80 percent of all outward FDI.
- The PRD is estimated to capture some 40 percent of Hong Kong SAR outward FDI.
- Guangdong provincial statistics indicate that over 70 percent of all FDI agreements signed between 1979 and 2006 are with Hong Kong SAR companies.
- Roughly, two-thirds of all Hong Kong SAR imports from the Mainland are sourced from Guangdong province.
- Since its opening in 1979, the PRD economic zone has served as Hong Kong SAR’s industrial hinterland, enabling:
  - the shifting of factories across the border,
  - access to relatively cheap industrial labor,
  - leveraging of Hong Kong SAR’s advantages in logistics, producer services, and finance.
- The greater PRD economy (Hong Kong SAR, Macao SAR, and the PRD economic zone in Guangdong Province) produces goods and services well in excess of US$500 billion a year.
- Combined population of the greater PRD: about 100 million.
- Average per capita GDP at market prices in 2006:
  - Greater PRD average: about US$6,000.
  - Hong Kong SAR: US$27,000.
- Key implications:
  - Cities in the PRD closest to Hong Kong SAR have been the primary beneficiaries of investment and income growth.
  - Structural change and shocks in the PRD have direct repercussions for growth, trade, corporate profitability, and increasingly financial sector performance in Hong Kong SAR.
  - Industrialization causing rising levels of transboundary pollution is a threat to Hong Kong SAR’s competitiveness as an international financial center.
  - Calls for greater policy coordination between Hong Kong SAR and the PRD in structural reform (including the investment and trade regime, and education), future infrastructure development to enhance connectivity, and environmental policy.

### II. The Pearl River Delta — Main Indicators and Trends
- PRD composition (nine cities per Enright and others, 2005): Guangzhou, Shenzhen, Foshan, Zhuhai, Jiangmen, Zhongshan, Dongguan, four districts and counties of Huizhou, and four districts and counties of Zhaoqing. Shenzhen, Dongguan and Huizhou form the Eastern PRD; Guangzhou is the Central PRD; the rest form the Western PRD. Together with Hong Kong SAR and Macao SAR, these nine cities are the greater PRD.
- Growth and structure:
  - In 2006, the PRD’s per capita GDP was three times the national average.
  - With only 3.3 percent of China’s total population, the region accounted for about 10 percent of the nation’s output.
  - Services share has increased, especially in Guangzhou and Shenzhen where services now account for more than one third of output.
- Shenzhen highlights:
  - Fourth largest container port in the world.
  - Hosts multinational companies’ global or regional sourcing centers (Aeon, IBM, Wal-Mart cited).
  - Highest concentration of financial services in the PRD region; hosts the mainland’s second stock exchange.
- Guangzhou highlights:
  - Hosted 651 exhibitions in 2006.
  - Guangzhou’s 11th Five-Year Program (2006−2010) lists priority business services (financial, logistics, product design and packaging, legal, accounting and information services) open to foreign companies.
- Regional concentration:
  - Guangzhou and Shenzhen represent about 23 percent and 16 percent, respectively, of the PRD’s registered population and account for nearly two-thirds of the region’s output.
  - Nearly half of all exports originate in Shenzhen.
  - Nearly half of foreign direct investment goes into Guangzhou and Shenzhen.
  - Five other municipalities each account for only 5 percent or less of the region’s output, exports, or inward foreign direct investment.

### III. Role of Clusters in PRD Economic Development
- Clusters enabled consolidation of downstream and upstream industries, deeper specialization, faster reaction to demand changes, and cost reductions through network externalities.
- Spatial specialization:
  - Eastern PRD: electronics and IT products.
  - Western PRD: higher weight in household appliances.
- Large-scale cluster investments:
  - Guangzhou: one of three auto manufacturing bases in China, with a capacity of over half a million cars in 2006. Honda plant (1998) initiated autos and parts cluster; later joined by Nissan, Toyota, and Hyundai. Around 450 auto and auto parts manufacturers have set up factories in Guangdong and surrounding cities, with special development zones in Foshan, Zhongshan, Shenzhen, and Huizhou’s Daya Bay.
  - Nanshan (Shenzhen): high tech cluster where electronics and other high tech goods made up 50 percent of total output in 2003; area attracted IBM, Compaq, Oracle, and local companies such as Huawei and Zhongxing.
  - Petrochemical industry: Guangzhou Royal Dutch Shell, a US$4.3 billion petrochemicals complex jointly set up by CNOOC and Shell Petrochemicals Company Ltd., completed construction at Daya Bay in Huizhou with an output capacity of 2.3 million tons per year. In addition, five oil-refining plants, five petrochemical plants and five [text truncated in source].

### IV. Industry Clusters and Sector Specializations (mapped)
- Clusters mapped by municipality (selected entries):
  - Guangzhou / Panyu
  - Shenzhen
  - Dongguan
  - Huizhou
  - Zhongshan
  - Foshan / Chencun (Flower farming, ornamental fish, turf farming)
  - Nanhai (Textiles, aluminum products, motorcycles, underwear)
  - Shunde
  - Jiangmen (Textiles, garments, paper, batteries)
- Representative sector specializations include:
  - Electrical appliances, woodworking, shipping containers, furniture, machinery, bicycles
  - Electronics computers, components, peripherals, garments, furniture, shoes, toys, watches, clocks, cutlery, kitchen tools, soldering machinery, angling equipment
  - Laser diodes, digital electronics, CD-ROMs, telephones, batteries, circuit boards, precision machinery, plastics, chemicals
  - Lighting fixtures, lamps, metal products, motorcycles, casual wear, locks, audio equipment
  - Industrial ceramics, ceramic artwork, needlework, textiles, children's garments
  - Autos and parts, transport equipment, electrical products, electronics, chemicals, garments, textiles, business services, software, toys
  - Sports goods, textiles, garments, jewellery, toys, electric supply equipment, shipping containers
  - Electronics, computer products, telecom products, ICs, toys, plastics, watches, clocks, oil paintings, port services, logistics, finance, printing, artificial trees

### V. Regional Disparities: Income, Exports, and FDI
- Per capita GDP and income gaps:
  - Shenzhen per capita GDP is "more than 1.6 times the regional average."
  - Average income in Shenzhen is "five times higher than in Zhaoqing."
- Exports and FDI disparities:
  - Exports per capita: Shenzhen vs Zhaoqing differ by "36 times."
  - Per capita FDI differences are "nearly 4:1 (between Zhuhai and Jiangmen)."
- Comparison with Hong Kong SAR:
  - Per capita income: PRD municipalities lag Hong Kong SAR by "2.6:1."
  - Per capita exports: lag by "2.8:1."
  - Per capita FDI: lag by "9.9:1."
- Data note: "Per capita estimates are based on registered population," which may overstate differences within PRD and understate differences with Hong Kong SAR.

### VI. Connectivity and Infrastructure Effects on Integration
- Negative relationship between distance to Hong Kong and:
  - Number of Hong Kong enterprises in PRD municipalities
  - Share of those municipalities in total FDI
  - Regression (illustrated in Figure 3): y = -0.0504x + 16.499; R2 = 0.112; stronger when excluding Guangzhou: y = -0.0747x + 17.306; R2 = 0.4002.
- Historical shift in PRD GDP share:
  - 1980: eastern PRD accounted for "14 percent" of PRD GDP.
  - Two and a half decades later: eastern PRD accounts for "45 percent" of PRD GDP.
- Access constraints:
  - Eastern PRD benefited from land access to Hong Kong.
  - Western PRD primarily accessible via ferry and cargo ship, described as "relatively time-consuming and costly."

### VII. Investment, Trade, and Services Links between Hong Kong SAR and the PRD
- Hong Kong as source of FDI:
  - During 1979−2006, Hong Kong companies signed "92,532 investment contracts" with "utilized capital amounting to US$112.2 billion," representing "63.2 percent" of Guangdong’s total foreign investment.
  - PRD is estimated to capture "more than 90 percent of utilized FDI in Guangdong."
  - Direct investment in Guangdong accounts for "41.3 percent" of Hong Kong’s total outward investment in the Mainland.
- PRD’s role in trade:
  - PRD accounts for "nearly one third of all Mainland exports."
  - PRD exports account for "about 95 percent of total exports from Guangdong in recent years."
  - "About 70 percent of PRD exports were in processing trade."
  - More than "one third" of Guangdong’s exports were routed through Hong Kong.
  - Guangdong’s share in Hong Kong’s mainland imports rose from "34 percent in 2000" to "70 percent in 2006."
- Forms of Hong Kong investment and enterprise counts:
  - Hong Kong-funded enterprises and Hong Kong enterprises in OCFs approximately accounted for "55,200 manufacturing enterprises and 57,500 factories in the PRD," representing "some 89 percent of all foreign invested enterprises."
  - More than 50 percent of these enterprises are in the Eastern PRD, especially Shenzhen and Dongguan.
  - Business model composition: "82 percent" operate in Original Equipment Manufacturing (OEM); "13 percent" are Original Brand Manufacturing (OBM).

### VIII. Firm-level Linkages, Supply Chains, and Role of Hong Kong Firms
- Trade routing and sourcing (FHKI survey):
  - "67 percent" of Hong Kong-invested enterprises in the PRD exclusively exported their goods through Hong Kong; an average of "44 percent" of exported goods was exported through Hong Kong.
  - "70 percent" of enterprises imported all their raw materials through Hong Kong; an average of "41 percent" of imported materials went through Hong Kong.
- Firms with activities in both Hong Kong SAR and PRD increased participation across regional headquarters, sales/marketing, research and development, IT management, procurement, financial management, logistics, production.
- Distribution of domestic sales (FHKI 2007): City of location "(39.4)"; Rest of Guangdong "(39.6)"; Yangtse River Delta "(12.2)"; Other "(8.8)".
- Primary business purposes and sales composition:
  - "52.4 percent" engaged in export only; "14.1 percent" in domestic sale only; "21.5 percent" in both businesses.
  - Based on average value: exports "68 percent," domestic sales "28 percent," internal transfers "4 percent."
  - Pearl River Delta distribution of sales by role (selected entries): "100 percent export" firms: "52.4" (All), "100.0" (Export), "0.0" (Transfer), "0.0" (Domestic sale); overall weighted average: "100.0" total; "68.0" Export; "3.9" Transfer; "28.2" Domestic sale.
- Case example: Li&Fung Ltd. operates subsidiaries and joint-ventures in Dongguan, Guangzhou, Huizhou, Shenzhen, and Zhongshan, providing product design, raw material sourcing, production coordination, logistics, and financing, leveraging PRD networks for global supply-chain management.

### IX. Financial Integration, CEPA, and Regulatory Frameworks
- CEPA role:
  - CEPA "played a key role in deepening the investment and trade linkages between Hong Kong SAR and the PRD and streamlining regulations as a basis for a more integrated common market."
  - CEPA strengthened Hong Kong SAR’s role as a trade and producer services hub and "provided momentum for further integration of financial services, which has been lagging so far."
- CEPA design and expansion:
  - CEPA of 2003 aimed to boost business confidence after SARS by advancing the WTO timetable for Hong Kong SAR companies, liberalizing the individual visit scheme to Hong Kong SAR, and ending the quota system for Mainland company listings on the Hong Kong SAR stock exchange.
  - Supplements (2004−2008) increased tariff-free goods to 1,510 and increased the number of service areas with preferential market access for Hong Kong SAR-based firms to 40.
- CEPA financial services provisions:
  - CEPA Supplement IV (July 2007): lowered size requirements for Hong Kong SAR banks from US$20 billion to US$6 billion in assets relative to WTO commitments.
  - Mainland commitment to support its banks in setting up subsidiary operations in Hong Kong SAR; example: takeover of Wing Lung Bank by Merchants Bank (headquartered in Shenzhen) in 2008.
  - Insurance: Hong Kong firms can form groups to fulfill minimum conditions for foreign insurers under WTO commitments; insurance agency companies can set up wholly-owned subsidiaries on the Mainland.
  - Securities and qualified Mainland company subsidiary restrictions eased to facilitate cross-border operations.
  - Green lanes for fast track approval of Hong Kong SAR bank branch applications in Guangdong and in Central, Western and North Eastern areas of the Mainland.
  - Agreement between Hong Kong SAR’s Office of the Commissioner of Insurance (OCI) and the China Insurance Regulatory Commission (CIRC): Hong Kong SAR residents can take qualifying examinations for insurance intermediaries in Shenzhen; an examination center was set up in Hong Kong in 2008.
  - Under CEPA, Hong Kong banks were allowed to conduct renminbi business on the Mainland ahead of the WTO timeline for other foreign banks.
- Other connectivity measures:
  - Since 2004 Hong Kong banks have been allowed to offer renminbi businesses under clearing arrangements provided by the People’s Bank of China.
  - As of August 2008, there were 40 banks in Hong Kong handling a total of nearly 1.2 million RMB accounts.
  - At end-June 2008, Hong Kong SAR banks were operating 198 branches and sub-branches on the Mainland, compared to 103 at end-2006 (a 92 percent increase). The number of branches or sub-branches in Guangdong accounts for 32 percent of the total.
- Measured economic impacts:
  - Hong Kong SAR government estimate: in the first three years of CEPA implementation 36,000 additional jobs were created in Hong Kong SAR.
  - Individual visitor scheme generated more than HK$7 billion in annual retail sales (3.6 percent of total) over 2004−07.
  - Ching, Hsiao and Wan (2008) estimate that CEPA added an average 2.8 percentage points to real GDP growth in Hong Kong SAR between 2004 and 2007.
  - Estimates indicate PRD companies account for 6 percent of Mainland companies’ market capitalization in Hong Kong SAR.

### X. Employment, Human Capital, and Mobility
- FHKI survey: Hong Kong enterprises employ a total of 9.6 million people in the PRD:
  - 5.9 million in the Eastern PRD,
  - 1.2 million in Guangzhou,
  - about 2.6 million in the Western PRD — overall equivalent to 40 percent of the workforce in the PRD.
- Proportion of Hong Kong SAR residents working in the Mainland increased from less than 2 percent of total (about 52,000) in 1988 to over 7½ percent (nearly 240,000) in 2004; nearly 90 percent estimated to work in Guangdong.
- About 80 percent of Hong Kong SAR residents working across the border are responsible for managing and supervising daily company operations.
- Direct and indirect employment effect in Hong Kong SAR by attracting PRD-related producer and trading services is estimated at 1.5 million jobs (40 percent of the labor force); this includes half a million workers directly employed by Hong Kong companies investing in the PRD, and one million in producer services linked to the PRD.
- Cross-border business trips by Hong Kong residents increased from 16 million in 2000 to nearly 23 million (an average of about 440,000 trips per week) five years later.
- FHKI survey findings: majority of respondents with operations in both PRD and Hong Kong SAR value maintaining Hong Kong offices for quality of business and professional services, free flow of information, and the legal and tax system; enterprises are not expected to significantly change the division of labor between Hong Kong and Guangdong over the medium term.

### XI. Environmental Costs of Integration (Air Pollution and Related Impacts)
- Since the early 1970s, the number of hazy days in Hong Kong SAR has risen ten-fold.
- Since 1996, concentration levels of most critical air pollutants, except suspended particulates, have increased significantly, in some cases by 20 percent or more.
- Monthly variations in pollution levels are closely correlated between Hong Kong SAR and the PRD and generally exceed internationally accepted norms in both areas.
- Pollution levels in Hong Kong are generally more closely linked with neighboring Shenzhen than with the PRD as a whole.
- On nearly 40 percent of days in a calendar year Hong Kong SAR’s air pollution is predominantly accounted for by sources from the PRD.
- Clean environment is essential to Hong Kong SAR’s competitiveness as an international financial center; pollution affects availability of skilled labor, health indicators, and property values.
- 2006 annual average air pollution charts and data indicate PM10, NO2, SO2, and O3 monthly averages for PRD and Hong Kong SAR relative to WHO (or USEPA) guidelines.
- Number of hazy days (visibility < 8 km) series presented from 1970 to 2002 shows a sharp increase; 2007 versus 1996 increases in gaseous pollutants include values up to 30 percent for some pollutants.

### XII. Policy Implications, Opportunities, and Recommended Actions
- Enhance connectivity through infrastructure improvements (example: planned Hong Kong-Macau-Zhuhai bridge to create first land-link between Hong Kong and western PRD, reducing time and cost).
- Harmonize policies and regulations to create a common market with frictionless movement of goods, services, and people; reduce costly frictions given high interdependence and supply-chain sophistication.
  - Example: median loss reported by enterprises from delays at customs between Hong Kong SAR and the PRD halved between 2003 and 2007.
  - Facilitate smooth flow of labor, particularly management, by easing visa restrictions for work-related travel.
- Further expand business opportunities under CEPA and allow outward processing operations in the PRD to expand domestic sales to tap Mainland market.
- Under phase V of CEPA, prioritize policies that promote transfer of knowledge to strengthen accounting standards, disclosure, risk management and financial literacy among the general public.
- Build an integrated skills base:
  - Leverage universities to attract more Mainland students to deepen regional specialization and attract multinational R&D activity.
  - UNESCO 2006 Global Education Digest: 343,126 Mainland students abroad; only 3,001 students in Hong Kong SAR from other Asian jurisdictions.
  - Non-local student quotas for publicly funded programs increased from 4 percent in academic year 2004/05 to 20 percent in 2008/09.
  - HK$1 billion scholarship fund started in 2008 could potentially provide full tuition to about 1,200 local or 600 non-local students when fully phased in.
  - In 2008, undergraduate students from the Mainland were about 6 percent of total non-local students (or less than a third of the quota); Hong Kong University data: demand from fee-paying Mainland students outstrips supply by a factor of 1:40; in 2006/07 Hong Kong University admitted 267 fee-paying Mainland students from a pool of 10,231 applicants.
  - Recommendation: expand access for students and technology personnel from the PRD to Hong Kong-based universities and invest to strengthen and expand tertiary education capacity.
- Tackle pollution with coordinated region-wide action:
  - Hong Kong SAR should enact and enforce air pollution standards in line with WHO standards and take the lead in tackling regional pollution in the PRD.
  - Consider greater PRD emission trading, for which the HKEX could be a platform.
  - Clear, predictable, and sector-applicable guidelines with sufficient lead-time are needed.
  - Note: April 2002 regional air quality management plan between Hong Kong SAR and Guangdong Province (1997 baseline) pursued reductions in SO2, Nox, RSP, and volatile organic compounds on a “best endeavor basis,” but statistical progress has been limited.
  - Emissions trading pilot scheme (ETPS) for thermal power plants in the PRD was adopted in January 2007 between Hong Kong SAR Environmental Protection Department (EPD) and Guangdong Environmental Protection Bureau (EPB); legal, administrative, and technical infrastructure issues remain and the pilot’s narrow scope, insufficient regulation levels, and limited enforcement capacity on the Guangdong side suggest participation and actual emissions reductions will be limited.

### XIII. Concluding Assessment
- Integration with the PRD transformed Hong Kong SAR into a producer services and finance hub and offers significant future benefits if managed well.
- Greater connectivity, policy coordination, and an expanded skills base are required to capture growth potential, particularly in the less advanced Western PRD.
- Policy coordination is also needed to minimize integration costs, notably rising cross-border pollution that threatens Hong Kong SAR’s competitiveness as an international financial center.

*Source: _wp08273 - References.*

### References..............................................................................................................

### _wp08273 - References..............................................................................................................

### I. Introduction — Integration between Hong Kong SAR and the Mainland (PRD)
- Between 2001 and 2006, the stock of Hong Kong SAR’s outward FDI into the Mainland nearly tripled to US$270 billion and accounted for almost 80 percent of all outward FDI.
- The PRD is estimated to capture some 40 percent of Hong Kong SAR outward FDI.
- Guangdong provincial statistics indicate that over 70 percent of all FDI agreements signed between 1979 and 2006 are with Hong Kong SAR companies.
- Roughly, two-thirds of all Hong Kong SAR imports from the Mainland are sourced from Guangdong province.
- Since its opening in 1979, the PRD economic zone has served as Hong Kong SAR’s industrial hinterland, enabling:
  - the shifting of factories across the border,
  - access to relatively cheap industrial labor,
  - leveraging of Hong Kong SAR’s advantages in logistics, producer services, and finance.
- The greater PRD economy (Hong Kong SAR, Macao SAR, and the PRD economic zone in Guangdong Province) produces goods and services well in excess of US$500 billion a year.
- Combined population of the greater PRD: about 100 million.
- Average per capita GDP at market prices in 2006:
  - Greater PRD average: about US$6,000.
  - Hong Kong SAR: US$27,000.
- Key implications highlighted:
  - Cities in the PRD closest to Hong Kong SAR have been the primary beneficiaries of investment and income growth.
  - Structural change and shocks in the PRD have direct repercussions for growth, trade, corporate profitability, and increasingly financial sector performance in Hong Kong SAR.
  - Industrialization causing rising levels of transboundary pollution is a threat to Hong Kong SAR’s competitiveness as an international financial center.
  - Calls for greater policy coordination between Hong Kong SAR and the PRD in:
    - structural reform (including the investment and trade regime, and education),
    - future infrastructure development to enhance connectivity,
    - environmental policy.

### II. The Pearl River Delta — Main Indicators and Trends
- Definition and composition of the PRD economic zone (nine cities in Guangdong province, per Enright and others, 2005):
  - Guangzhou (provincial capital), Shenzhen, Foshan, Zhuhai, Jiangmen, Zhongshan, Dongguan, four districts and counties of Huizhou, and four districts and counties of Zhaoqing.
  - Shenzhen, Dongguan and Huizhou form the Eastern PRD; Guangzhou is the Central PRD; the rest form the Western PRD.
  - Together with Hong Kong SAR and Macao SAR, these nine cities are the greater PRD.
- Growth and structure:
  - Since 1979, Guangdong province and the PRD experienced rapid economic change and development.
  - In 2006, the PRD’s per capita GDP was three times the national average.
  - With only 3.3 percent of China’s total population, the region accounted for about 10 percent of the nation’s output.
  - While industrialization was the initial driver, the share of services in output has increased in recent years, especially in Guangzhou and Shenzhen where services now account for more than one third of output (Table 1).
- Shenzhen highlights:
  - Fourth largest container port in the world (logistics).
  - Hosts multinational companies’ global or regional sourcing centers (Aeon, IBM, Wal-Mart cited).
  - Highest concentration of financial services in the PRD region; hosts the mainland’s second stock exchange.
- Guangzhou highlights:
  - One of the leading trade fair centers in China, hosting 651 exhibitions in 2006.
  - Guangzhou’s 11th Five-Year Program (2006−2010) lists priority development targets in business services: financial, logistics, product design and packaging, legal, accounting and information services; all these areas are open to foreign companies.
- Regional concentration and disparities:
  - Guangzhou and Shenzhen represent about 23 percent and 16 percent, respectively, of the PRD’s registered population and account for nearly two-thirds of the region’s output (Table 2 and Figure 1).
  - Nearly half of all exports originate in Shenzhen.
  - Nearly half of foreign direct investment goes into Guangzhou and Shenzhen.
  - Five other municipalities each account for only 5 percent or less of the region’s output, exports, or inward foreign direct investment.

### III. Role of Clusters in PRD Economic Development (Box 1)
- Emergence of industry and services clusters has been a key feature of PRD growth, allowing consolidation of downstream and upstream industries, deeper specialization, faster reaction to demand changes, and cost reductions through network externalities.
- Spatial specialization:
  - Eastern PRD focuses on electronics and IT products.
  - Western PRD has a relatively high weight in household appliances.
- Examples of large-scale cluster investments:
  - Guangzhou: becoming one of the three auto manufacturing bases in China, with a capacity of over half a million cars in 2006.
    - Honda plant set up in 1998 initiated the autos and parts cluster; later joined by Nissan, Toyota, and Hyundai.
    - Around 450 auto and auto parts manufacturers have set up factories in Guangdong and surrounding cities, with special development zones in Foshan, Zhongshan, Shenzhen, and Huizhou’s Daya Bay.
  - Nanshan (Shenzhen): prominent high tech cluster where electronics and other high tech goods made up 50 percent of total output in 2003.
    - Area has attracted IBM, Compaq, Oracle, and local companies such as Huawei and Zhongxing.
  - Petrochemical industry: Guangzhou Royal Dutch Shell, a US$4.3 billion petrochemicals complex jointly set up by CNOOC and Shell Petrochemicals Company Ltd., completed construction at Daya Bay in Huizhou (JV company to produce about [text truncated in source]).

*Source: _wp08273 - References..............................................................................................................*

### 2.3 million tons per year. In addition, five oil-refining plants, five petrochemical plants and five

### _wp08273 - 2.3 million tons per year. In addition, five oil-refining plants, five petrochemical plants and five

### Industry clusters in the Pearl River Delta (PRD)
- Clusters mapped to municipalities and districts (as listed):
  - Guangzhou / Panyu 1/
  - Shenzhen
  - Dongguan
  - Huizhou
  - Zhongshan
  - Foshan / Chencun 1/Flower farming, ornamental fish, turf farming
  - Nanhai 1/Textiles, aluminum products, motorcycles, underwear
  - Shunde 1/
  - JiangmenTextiles, garments, paper, batteries
- Representative sector specializations (excerpted):
  - Electrical appliances, woodworking, shipping containers, furniture, machinery, bicycles
  - Electronics computers, components, peripherals, garments, furniture, shoes, toys, watches, clocks, cutlery, kitchen tools, soldering machinery, angling equipment
  - Laser diodes, digital electronics, CD-ROMs, telephones, batteries, circuit boards, precision machinery, plastics, chemicals
  - Lighting fixtures, lamps, metal products, motorcycles, casual wear, locks, audio equipment
  - Industrial ceramics, ceramic artwork, needlework, textiles, children's garments
  - Autos and parts, transport equipment, electrical products, electronics, chemicals, garments, textiles, business services, software, toys
  - Sports goods, textiles, garments, jewellery, toys, electric supply equipment, shipping containers
  - Electronics, computer products, telecom products, ICs, toys, plastics, watches, clocks, oil paintings, port services, logistics, finance, printing, artificial trees

### Regional disparities: income, exports, and FDI
- Per capita GDP and income gaps:
  - Shenzhen per capita GDP is "more than 1.6 times the regional average."
  - Average income in Shenzhen is "five times higher than in Zhaoqing."
- Exports and FDI disparities:
  - Exports per capita: Shenzhen vs Zhaoqing differ by "36 times."
  - Per capita FDI differences are "nearly 4:1 (between Zhuhai and Jiangmen)."
- Comparison with Hong Kong SAR:
  - Per capita income: PRD municipalities lag Hong Kong SAR by "2.6:1."
  - Per capita exports: lag by "2.8:1."
  - Per capita FDI: lag by "9.9:1."
- Note on data: "Per capita estimates are based on registered population," with potential biases noted (may overstate differences within PRD and understate differences with Hong Kong SAR).

### Connectivity and infrastructure effects on integration
- Negative relationship documented between distance to Hong Kong and:
  - Number of Hong Kong enterprises in PRD municipalities
  - Share of those municipalities in total FDI (illustrated in Figure 3; regression: y = -0.0504x + 16.499; R2 = 0.112; stronger when excluding Guangzhou: y = -0.0747x + 17.306; R2 = 0.4002).
- Historical shift in PRD GDP share:
  - 1980: eastern PRD accounted for "14 percent" of PRD GDP.
  - Two and a half decades later (circa mid-2000s): eastern PRD accounts for "45 percent" of PRD GDP.
- Access constraints:
  - Eastern PRD (e.g., Shenzhen, Dongguan) benefited from land access to Hong Kong.
  - Western PRD primarily accessible via ferry and cargo ship, described as "relatively time-consuming and costly."

### Investment, trade, and services links between Hong Kong SAR and the PRD
- Hong Kong as source of FDI:
  - During 1979−2006, Hong Kong companies signed "92,532 investment contracts" with "utilized capital amounting to US$112.2 billion," representing "63.2 percent" of Guangdong’s total foreign investment (Table 3).
  - PRD is estimated to capture "more than 90 percent of utilized FDI in Guangdong (Table 4)."
  - Matching with Hong Kong statistics suggests direct investment in Guangdong accounts for "41.3 percent" of Hong Kong’s total outward investment in the Mainland.
- PRD’s role in trade:
  - PRD accounts for "nearly one third of all Mainland exports."
  - Exports from PRD account for "about 95 percent of total exports from Guangdong in recent years."
  - "About 70 percent of PRD exports were in processing trade."
  - More than "one third" of Guangdong’s exports were routed through Hong Kong, a share described as relatively steady.
  - Guangdong’s share in Hong Kong’s mainland imports rose from "34 percent in 2000" to "70 percent in 2006."
- Forms of Hong Kong investment and enterprise counts:
  - Hong Kong-based investment in PRD mainly takes the form of foreign-invested enterprises (FIEs) and other contractual forms (OCFs).
  - FHKI 2007 survey figures: Hong Kong-funded enterprises and Hong Kong enterprises in OCFs approximately accounted for "55,200 manufacturing enterprises and 57,500 factories in the PRD," representing "some 89 percent of all foreign invested enterprises."
  - Geographical concentration: "More than 50 percent of these enterprises are in the Eastern PRD," especially Shenzhen and Dongguan.
  - Business model composition: "82 percent" of Hong Kong-related enterprises operate in Original Equipment Manufacturing (OEM); "13 percent" are Original Brand Manufacturing (OBM).

### Firm-level linkages, supply chains, and role of Hong Kong firms
- Trade routing and sourcing (FHKI survey):
  - Exports: "67 percent" of Hong Kong-invested enterprises in the PRD exclusively exported their goods through Hong Kong; an average of "44 percent" of exported goods was exported through Hong Kong.
  - Raw material imports: "70 percent" of enterprises imported all their raw materials through Hong Kong; an average of "41 percent" of imported materials went through Hong Kong.
- Firm activities split between Hong Kong SAR and PRD:
  - Share of firms with activities in both locations increased across areas such as regional headquarters, sales/marketing, research and development, IT management, procurement, financial management, logistics, production (Table 5 summary described).
  - Distribution of domestic sales (FHKI 2007): City of location "(39.4)"; Rest of Guangdong "(39.6)"; Yangtse River Delta "(12.2)"; Other "(8.8)".
- Primary business purposes and sales composition:
  - Among enterprises surveyed: "52.4 percent" engaged in export only; "14.1 percent" in domestic sale only; "21.5 percent" in both businesses.
  - Based on average value of products: exports accounted for "68 percent," domestic sales "28 percent," internal transfers "4 percent."
  - Pearl River Delta distribution of sales by role (selected entries):
    - "100 percent export" firms: "52.4" (All), "100.0" (Export), "0.0" (Transfer), "0.0" (Domestic sale)
    - Overall weighted average: "100.0" total; "68.0" Export; "3.9" Transfer; "28.2" Domestic sale
- Example of supply-chain management: Li&Fung Ltd.
  - Li&Fung operates subsidiaries and joint-ventures in Dongguan, Guangzhou, Huizhou, Shenzhen, and Zhongshan.
  - The company provides services spanning product design, raw material sourcing, production coordination, logistics, and financing, leveraging PRD networks for global supply-chain management.

### Financial integration and regulatory frameworks
- CEPA (Closer Economic Partnership Agreement) effects:
  - CEPA has "played a key role in deepening the investment and trade linkages between Hong Kong SAR and the PRD and streamlining regulations as a basis for a more integrated common market."
  - CEPA has strengthened Hong Kong SAR’s role as a trade and producer services hub and "provided momentum for further integration of financial services, which has been lagging so far."
- Financial market linkages:
  - Mainland listings and their share in market capitalization in Hong Kong noted, but financial integration described as "much less advanced" relative to trade and investment integration.

*Source: Excerpt from IMF working paper _wp08273 (pages and tables as presented in the source PDF).*

### Box 4. The Integrative Role of the Closer Economic Partnership Agreement (CEPA)

### Box 4. The Integrative Role of the Closer Economic Partnership Agreement (CEPA)

### CEPA design, scope, and expansion
- CEPA of 2003: first free trade agreement of Mainland China with the objective to boost business confidence in Hong Kong SAR after the SARS crisis by advancing the WTO timetable for Hong Kong SAR companies, liberalizing the individual visit scheme to Hong Kong SAR, and ending the quota system for Mainland company listings on the Hong Kong SAR stock exchange.
- Supplements signed between 2004 and 2008 increased tariff-free goods to 1,510 and increased the number of service areas with preferential market access for Hong Kong SAR-based firms to 40.

### CEPA and financial services integration — specific provisions
- CEPA Supplement IV (signed July 2007): widened access to the Mainland market for Hong Kong SAR banks by lowering size requirements relative to WTO commitments from US$20 billion to US$6 billion in assets.
- Mainland commitment to support its banks in setting up subsidiary operations in Hong Kong SAR; example: takeover of Wing Lung Bank by Merchants Bank (headquartered in Shenzhen) in 2008.
- Insurance: Hong Kong firms can form groups to fulfill minimum conditions for foreign insurers under WTO commitments; insurance agency companies can set up wholly-owned subsidiaries on the Mainland.
- Securities and qualified Mainland company subsidiary restrictions eased to facilitate cross-border operations.
- Green lanes established for fast track approval of Hong Kong SAR bank branch applications in Guangdong and in Central, Western and North Eastern areas of the Mainland.
- Agreement between Hong Kong SAR’s Office of the Commissioner of Insurance (OCI) and the China Insurance Regulatory Commission (CIRC): Hong Kong SAR residents can take qualifying examinations for insurance intermediaries in Shenzhen; an examination center was set up in Hong Kong in 2008.
- Under CEPA, Hong Kong banks were allowed to conduct renminbi business on the Mainland ahead of the WTO timeline for other foreign banks.

### Other schemes linked to CEPA and financial connectivity
- Since 2004 Hong Kong banks have been allowed to offer renminbi businesses under clearing arrangements provided by the People’s Bank of China.
- As of August 2008, there were 40 banks in Hong Kong handling a total of nearly 1.2 million RMB accounts.
- At end-June 2008, Hong Kong SAR banks were operating 198 branches and sub-branches on the Mainland, compared to 103 at end-2006 (a 92 percent increase). The number of branches or sub-branches in Guangdong accounts for 32 percent of the total.

### Economic benefits and measured impacts of CEPA
- Hong Kong SAR government estimate: in the first three years of CEPA implementation 36,000 additional jobs were created in Hong Kong SAR.
- Individual visitor scheme generated more than HK$7 billion in annual retail sales (3.6 percent of total) over the period 2004−07.
- Ching, Hsiao and Wan (2008) estimate that CEPA added an average 2.8 percentage points to real GDP growth in Hong Kong SAR between 2004 and 2007.
- Estimates indicate PRD companies account for 6 percent of Mainland companies’ market capitalization in Hong Kong SAR.

### Employment and human capital linkages
- FHKI survey: Hong Kong enterprises employ a total of 9.6 million people in the PRD, among which 5.9 million in the Eastern PRD, 1.2 million in Guangzhou and about 2.6 million in the Western PRD — overall equivalent to 40 percent of the workforce in the PRD.
- Proportion of Hong Kong SAR residents working in the Mainland increased from less than 2 percent of total (about 52,000) in 1988 to over 7½ percent (nearly 240,000) in 2004; nearly 90 percent estimated to work in Guangdong.
- About 80 percent of Hong Kong SAR residents working across the border are responsible for managing and supervising daily company operations.
- Direct and indirect employment effect in Hong Kong SAR by attracting PRD-related producer and trading services is estimated at 1.5 million jobs (40 percent of the labor force); this estimate includes half a million workers directly employed by Hong Kong companies investing in the PRD, and one million in producer services linked to the PRD.
- Cross-border business trips by Hong Kong residents increased from 16 million in 2000 to nearly 23 million (an average of about 440,000 trips per week) five years later.
- FHKI survey results: a majority of respondents with operations in both PRD and Hong Kong SAR value maintaining Hong Kong offices for quality of business and professional services, free flow of information, and the legal and tax system; enterprises are not expected to significantly change the division of labor between Hong Kong and Guangdong over the medium term.

### Environmental costs of integration (air pollution and related impacts)
- Since the early 1970s, the number of hazy days in Hong Kong SAR has risen ten-fold.
- Since 1996, concentration levels of most critical air pollutants, except suspended particulates, have increased significantly, in some cases by 20 percent or more.
- Monthly variations in pollution levels are closely correlated between Hong Kong SAR and the PRD and generally exceed internationally accepted norms in both areas.
- Geographical data: pollution levels in Hong Kong are generally more closely linked with neighboring Shenzhen than with the PRD as a whole.
- On nearly 40 percent of days in a calendar year Hong Kong SAR’s air pollution is predominantly accounted for by sources from the PRD.
- Clean environment is essential to Hong Kong SAR’s competitiveness as an international financial center; pollution affects availability of skilled labor, health indicators, and property values.
- 2006 annual average air pollution charts and data indicate PM10, NO2, SO2, and O3 monthly averages for PRD and Hong Kong SAR relative to WHO (or USEPA) guidelines.
- Number of hazy days (visibility < 8 km) series presented from 1970 to 2002 showing a sharp increase; 2007 versus 1996 increases in gaseous pollutants include values up to 30 percent for some pollutants.

### Policy implications, opportunities, and recommended actions
- Enhance connectivity through infrastructure improvements (example: planned Hong Kong-Macau-Zhuhai bridge to create first land-link between Hong Kong and western PRD, reducing time and cost).
- Harmonize policies and regulations to create a common market with frictionless movement of goods, services, and people; reduce costly frictions given high interdependence and supply-chain sophistication.
  - Example: median loss reported by enterprises from delays at customs between Hong Kong SAR and the PRD halved between 2003 and 2007.
  - Facilitate smooth flow of labor, particularly management, by easing visa restrictions for work-related travel.
- Further expand business opportunities under CEPA and allow outward processing operations in the PRD to expand domestic sales to tap Mainland market.
- Under phase V of CEPA, prioritize policies that promote transfer of knowledge to strengthen accounting standards, disclosure, risk management and financial literacy among the general public.
- Build an integrated skills base:
  - Hong Kong SAR should leverage universities to attract more Mainland students to deepen regional specialization and attract multinational R&D activity.
  - Hong Kong SAR lags comparable economies in international student mobility: UNESCO 2006 Global Education Digest shows 343,126 Mainland students abroad; only 3,001 students in Hong Kong SAR from other Asian jurisdictions.
  - Non-local student quotas for publicly funded programs increased from 4 percent in academic year 2004/05 to 20 percent in 2008/09.
  - HK$1 billion scholarship fund started in 2008 could potentially provide full tuition to about 1,200 local or 600 non-local students when fully phased in.
  - In 2008, undergraduate students from the Mainland were about 6 percent of total non-local students (or less than a third of the quota); Hong Kong University data: demand from fee-paying Mainland students outstrips supply by a factor of 1:40; in 2006/07 Hong Kong University admitted 267 fee-paying Mainland students from a pool of 10,231 applicants.
  - Recommendation: expand access for students and technology personnel from the PRD to Hong Kong-based universities and invest to strengthen and expand tertiary education capacity.
- Tackle pollution with coordinated region-wide action:
  - Hong Kong SAR should enact and enforce air pollution standards in line with WHO standards and take the lead in tackling regional pollution in the PRD.
  - Consider greater PRD emission trading, for which the HKEX could be a platform.
  - Clear, predictable, and sector-applicable guidelines with sufficient lead-time are needed.
  - Note: April 2002 regional air quality management plan between Hong Kong SAR and Guangdong Province aimed to reduce emissions of SO2, Nox, RSP, and volatile organic compounds using a 1997 baseline on a “best endeavor basis,” but statistical progress has been limited.
  - Emissions trading pilot scheme (ETPS) for thermal power plants in the PRD was adopted in January 2007 between Hong Kong SAR Environmental Protection Department (EPD) and Guangdong Environmental Protection Bureau (EPB); however, legal, administrative, and technical infrastructure issues remain to be addressed and the pilot’s narrow scope, insufficient regulation levels, and limited enforcement capacity on the Guangdong side suggest participation and actual emissions reductions will be limited.

### Concluding assessment
- Integration with the PRD transformed Hong Kong SAR into a producer services and finance hub and offers significant future benefits if managed well.
- Greater connectivity, policy coordination, and an expanded skills base are required to capture growth potential, particularly in the less advanced Western PRD.
- Policy coordination is also needed to minimize integration costs, notably rising cross-border pollution that threatens Hong Kong SAR’s competitiveness as an international financial center.

*Source: _wp08273 - Box 4. The Integrative Role of the Closer Economic Partnership Agreement (CEPA)*

### References

### _wp08273 - References

### Academic articles and working papers
- Ching, Steve, Cheng Hsiao, and Shui Ki Wan, 2008, “A Panel Data Approach for Program Evaluation—Measuring the Benefits of Political and Economic Integration of Hong Kong with Mainland China,” mimeo. (Hong Kong: City University of Hong Kong).
- Leung, Cynthia, and Olaf Unteroberdoerster, 2008, “Hong Kong SAR as a Financial Center for Asia: Trends and Implications,” IMF Working Paper 08/57 (Washington: International Monetary Fund).
- Wong, Y.C.R., Z. Tao, and C.S. Chan, 2000, “An Economic Study of Hong Kong’s Producer Services Sector and Its Role in Supporting Manufacturing,” in Made in PRD: The Changing Face of Hong Kong Manufacturers (Hong Kong: Federation of Hong Kong Industries (FHKI), 2003).

### Reports and policy studies
- Civic Exchange, 2008, A Price too High: The Health Impacts of Air Pollution in Southern China (Hong Kong SAR).
- Civic Exchange, 2008, Beyond the Pearl River Delta: The Contest Begins (Hong Kong SAR).
- Krotman, Adam and Daniel Malech, 2007, Combating Air Pollution in the PRD: Emissions Trading as a Promising Policy Tool? (Hong Kong SAR: Civic Exchange).
- Hong Kong Trade and Development Council, 2008, “Latest Developments and Strategies of Hong Kong Companies’ Processing Trade Business in the Pearl River Delta—Survey Findings,” (Hong Kong SAR).
- Federation of Hong Kong Industries, 2007, Made in PRD: Challenges and Opportunities for Hong Kong Industry, (Hong Kong SAR).

### Books and company histories / case studies
- Enright, Michael and Edith Scott, 2006, “The Greater Pearl River Delta,” (Hong Kong: Invest Hong Kong, 2006).
- Enright, Michael and Ka-mun Chang, 2005, The Greater Pearl River Delta and the Rise of China (Singapore: John Whiley & Sons).
- Feng, Bang-Yan, 2007, 100 Years of Li&Fung: Rise from Family Business to Multinational (Singapore: Thomson Asia Ltd).
- O’Connell, Jamie, 1996, “Li&Fung (Trading) Limited,” Harvard Business Case Studies, 9-396-075, June 28.

### International organization publications
- United Nations Educational, Scientific and Cultural Organization, 2006, Global Education Digest, Comparing Education Statistics Across the World (Montreal, Quebec: UNESCO Institute for Statistics).

*Source: _wp08273 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp08273.pdf_