Two months ago, a group of European tourists and their Hong Kong-based host were at a table in one of the swanky new bars and restaurants that grace Macau's waterfront. The strip where they were relaxing sprang up almost overnight, grafting a stylish entertainment centre on to the unprepossessing area of reclaimed land between the ferry terminal and the Lisboa hotel and casino. Macau's promoters touted the area as the enclave's Lan Kwai Fong, which was doing it something of a disservice. The bars were better, the prices a fraction of those in Hong Kong, the look was chic. Better still, revellers could spill on to the street outside, or wander over the road to the sea front. What better symbol of this transformation than the graceful golden statue of Kwun Yam, goddess of mercy, which stares down on the scene with a face full of compassion and tranquility? Then, in an instant, the atmosphere changed. Five or six men, several wearing crash helmets, walked into one of the bars where an American band were playing. In a matter of seconds the bar was deserted - crash helmets in Macau have a habit of hiding assassins. Their leader, a short stocky man with black hair cascading from his helmet, walked up to one of the band members and calmly stubbed out his cigarette on the man's bare chest. It was a stark warning over a supposed romantic indiscretion. The bar, one of the most popular in Macau, shut up shop shortly afterwards, though it has since reopened. This is part of Macau's problem: like a cheap whore, you can dress it up but when you scratch the surface seediness oozes out. This dark side has been a double-edged sword. The government relies heavily on the gaming industry, which remains its single biggest source of revenue. Despite attempts to diversify, the gambling-earnings proportion of the budget has been climbing. From 32 per cent of revenue in 1992 it hit 56.9 per cent in 1998. With the gambling, the government accepts the inevitable prostitution, organised crime and violence. Indeed, the brooding prospect of danger lends a night in Macau a frisson of excitement that is undoubtedly part of its attraction, but when the violence boils over it becomes counterproductive. The vicious triad turf war that has claimed about 40 lives since it erupted in 1996 has played havoc with tourism. The Macau government has made a high-profile attempt to crack down on this violence, particularly with its prosecution of 14K leader 'Broken Tooth' Wan Kuok-koi and his gang, during which Wan was jailed for 15 years. The arrival of mainland security forces is also expected to tighten the screw on organised crime. Beijing has been unimpressed by the antics of organised criminals in Macau and has said it is prepared to commit up to 10,000 security personnel to ensure law and order if Macau is unable to do so. Even if gaming is tolerated by Macau's new rulers, the opportunities to expand the sector are limited by its other neighbour, Hong Kong. The Hong Kong Government has been incensed by Macau's attempts to facilitate gambling on the enclave's horse races inside Hong Kong - understandable given the importance of gambling revenue to the SAR's finances and the social spending of the Jockey Club. In many ways this paradox is typical of Macau. As a small, open economy trapped between two domineering neighbours Macau finds itself backed into a corner. Deciding how best to escape this trap and prosper is the great challenge facing the new administration. There are some signs Macau's dependency on gaming may be about to change. Of the 8.2 billion patacas (about HK$7.79 billion) collected in revenue in the first nine months of 1999, only 3.4 billion - 41 per cent - came from gambling. In September, 80,981 people arrived on package tours - a healthy 29.12 per cent up on the year before, according to the monetary authority - with Hong Kong tourists very much in the minority. The mainland accounted for more than half, with Taiwan and Japan taking up the next biggest portions. Together, these three accounted for 85.4 per cent of visitors in package tours, according to the statistics and census department. While tourist arrivals were up 5.3 per cent in the first nine months, Hong Kong visitors were down 13.86 per cent. Overall, however, the tourism industry struggles with low hotel occupancy - 47.7 per cent, a rise of just 0.7 percentage points from a year earlier - and, more importantly, the fact that visitors remain overwhelmingly short-stay. The average length of stay - discounting the hordes of day-trippers - was just 1.39 nights, down 0.08 per cent from a year earlier. In this sector, Hong Kong visitors were dominant - at 42.1 per cent - with mainlanders making up 35.4 per cent and Taiwanese 9.8 per cent. Moving the visitor mix away from Hong Kong's high-rollers also could be risky. While the occupancy rate at hotels has inched up, the biggest gains have been in the middle of the market. While three-star hotels saw a 3.03 per cent rise in occupancy rates, four and five-star operators saw their rates rise just 0.2 per cent. Prising money from unwilling pockets is seen as crucial to building up the non-gaming side of the tourism industry. 'Macau has seven million visitors a year. If they would stay one more day our economy could climb,' says Eric Yeung Tsun-man, director of Perfekta Toys and head of the Macau Productivity and Technology Transfer Centre. Dr Yeung, who had been widely touted as a candidate for chief executive and was a member of the appointing selection committee, is sanguine about Macau's future prospects. The Portuguese administration had done some good work in 'bits and pieces', Mr Yeung said, citing the development of museums and restoration of much of the historic architecture. The task that lay ahead would be to integrate the tourist experience, he said, and work harder to find more projects. One area that has potential is in conferences, exhibitions and special events. Macau has a proven track record with events such as the Grand Prix and fireworks festivals. Earlier this year, it also played host to a glittering array of central bankers at the new convention and exhibition centre. The positive response from bankers to the event had even the organisers at the Monetary and Foreign Exchange Authority scratching their heads. As with other small, open economies around the world, Macau's best hope for a prosperous future lies in carving out a niche rather than competing head on with its bigger neighbours. Tourism and gambling represent only half the picture. As a conduit for manufactured goods from the Zhuhai Special Economic Zone, Macau has enjoyed similar benefits to those derived by Hong Kong from its relationship with Shenzhen. Macau imports about US$5 billion worth of goods from China, re-exporting the bulk to the United States (48 per cent) and the European Union (about 35 per cent). Macau, like Hong Kong, has been able to build on its position as a free port providing access to the mainland. The longer term outlook, however, is uncertain. The mainland's entry into the World Trade Organisation is likely to undermine the importance of the free ports. Access to markets and distribution channels should remove the need for such intermediaries, though Dr Yeung disagrees. The argument, he said, was analogous to that made by proponents of the Internet, who believed the death of the middleman was imminent - instead we had seen the growth of a new class of intermediary, he said. For Macau, a further possible ramification of accession to the WTO is that it may spell the end of the quota system, of which Macau has been a big beneficiary. With Macau's quotas gone, the outlook for the enclave's textile industry could be grim. However, Dr Yeung remains bullish. 'Only those who don't want to change will not be able to survive,' he said. The opening of the mainland market in the past two decades had been a big opportunity for Hong Kong and Macau businessmen. Its further opening should not be viewed as a threat but as an extension of that opportunity, he added. Where Macau could carve its own niche was in building relations between small and medium-sized enterprises, Dr Yeung said. Inevitably, however, competition from lower-cost ports in the mainland's southern region will continue to eat into both Hong Kong and Macau's competitive advantages. The enclave also has only a small industrial base, primarily engaged in the manufacture of textiles and apparel, which account for about 80 per cent of exports. Dr Yeung sees the future for Macau's industrial sector in a drive towards value-added manufacturing, rather than a vain attempt to build scale or market share. Use of new materials, designing rather than simply assembling, and using technology to make manufacturers more responsive and flexible to clients' needs were all ways to add value to Macau's manufacturing base. Macau's performance during the Asian crisis bodes well for the future. It certainly seems to have weathered its recent problems. For the first nine months of this year the trade surplus rose at a healthy 31.1 per cent year on year to 930 million patacas. This was attributed by the monetary authority to a faster rise in exports rather than a contraction in imports. The US continued to account for the lion's share of trade, absorbing 48 per cent of Macau's exports. That represents a year-on-year growth of 7.4 per cent, according to the authority. Macau's links with Europe bode well for the future, the authority said, pointing to signs of stronger economic recovery in the EU. Interest rates have responded accordingly with the Macau interbank-offered rate shifting downwards, although the authority cautioned this might have more to do with improved liquidity in Hong Kong as fears of Y2K problems eased and speculators unwound their aggressive short positions against the Hong Kong dollar. As ever, the authority has an eye firmly on the well-being of its two big neighbours and points to signs of strong economic recovery in Hong Kong, where gross domestic product growth hit 4.5 per cent in the third quarter. Dr Yeung argues it is unrealistic to expect the return to economic health to be 'like opening instant noodles'. The process of rebuilding confidence will be gradual, and will require ingenuity and commitment from Macau's business community, he adds, but the future is there for the taking.