Re-exports disguise Hong Kong's gloomy outlook
Mainland companies sell goods at near cost to local affiliates and then re-export them at marked up prices
Gosh, everyone's gone gloomy all of a sudden. On Friday the Hong Kong government announced that the city's economic output fell by 0.1 per cent in the second quarter of the year, compared with the first three months (see the first chart).
In response, the government promptly cut its growth forecast for the whole of 2012 to a measly 1 to 2 per cent, down from its previous forecast of between 1 and 3 per cent growth.
Compared with last year's 5 per cent growth rate, that's quite a slow-down. And with global trade weak thanks to the euro-zone crisis, and China's economy slowing, private sector analysts were quick to warn that things are only going to get worse over the coming months.
Don't lose any sleep, however. All this pessimism is being laid on a bit too thick.
Part of the reason the second quarter looked so weak was because the preliminary numbers for the first three months of the year were revised upwards after new data showed a stronger performance in the services sector than initially thought. A similar revision is equally likely for the second quarter when more detailed figures come in.
But the main reason we don't have to worry too much is that the sector now experiencing the deepest slump has nothing to do with Hong Kong's real economy.
I know Jake van der Kamp has made this point before, but it's well worth making again.
The biggest drag on Hong Kong's economy in the second quarter was the city's exports of goods, which were down 0.4 per cent compared with the same period last year. Given that our exports equalled 189 per cent of our gross domestic product, that's a big enough fall to weigh heavily on our overall performance.
Except, of course, those goods weren't really exported by Hong Kong at all. In fact 97 per cent of them were re-exports. These are goods that the city imports, mostly from the mainland. Then, according to the Trade Development Council, Hong Kong somehow adds 15.9 per cent to their value, before shipping them on to the rest of the world.
This is pure fantasy. What actually happens is that mainland exporters sell goods to Hong Kong affiliates at near cost price. This allows them to declare only meagre profits at home, where the corporate tax rate is a stiff 25 per cent.
They then mark up the price before re-exporting the goods to the rest of the world, booking the lion's share of their profits in Hong Kong, where the corporate tax rate is a more friendly 16.5 per cent.
Even better, if the mainland exporter wants to bring his earnings back onshore, they now are classed as foreign inward investment and qualify for all sorts of tax breaks and incentives.
According to one estimate, in 2010 around HK$310 billion was round-tripped back to the mainland in this fashion. That would account for two-thirds of the value Hong Kong is supposed to add to its re-exports.
No doubt much of the rest was used to buy "luxury" apartments in deserted new developments in Kowloon, or was squirrelled away in private banks in Singapore.
In short, this value Hong Kong was said to add to its exports had little impact on the city's real economy, except to inflate property prices at the more ostentatious end of the market.
If weakening demand for China's exports now means less of that funny money flows through Hong Kong, the vast majority of the city's population will shed no tears.
Our headline rate of GDP growth may fall, but most people will feel no effect on their day to day lives.
What really matters is the rate of unemployment.
And as the second chart shows, that's currently just 3.2 per cent: as low as at the height of the pre-crisis boom in 2008. With the labour force participation rate as high now as then, that's an extremely strong position from which to head into a downturn.
So although no doubt we will hear a great many more gloomy forecasts over the coming months, the real view for Hong Kong is actually still rather bright.