In this blog we explore the roots of tax havenry in Hong Kong, now a Chinese 'Special Administrative Region' but formerly a British colony which prided itself on being at the cutting edge of laissez-faire capitalism. Hong Kong ranked number three on the 2013 Financial Secrecy Index.
Hong Kong is one of the world’s fastest growing secrecy
jurisdictions or tax havens today. Its growth is based largely on the fact that
it is the premier offshore centre for a fast-growing China, as well as rapid
growth more generally in Asia - and also, to a lesser extent, because of the
displacement to Hong Kong of some secrecy-based activity from Europe and North
America, amid limited crackdowns there since 2009.
Hong Kong’s official designation as a “Special Administrative
Region” of China, and its Basic Law stating that it enjoys ‘a high degree of
autonomy’ from China in all matters except foreign relations and defence, points clearly
to its ‘offshore’ status. Indeed, China has supported Hong Kong’s secrecy
facilities in the face of international pressure[i]. In
this and other respects the Hong Kong-China link resembles Britain’s links with
crown dependencies and 14 overseas territories – of which 10 are recognised
secrecy jurisdictions: partly independent from Britain yet also partly linked
to and supported by it.
Hong Kong built itself up over the decades on a spirit of extreme laissez-faire and anti-tax, and even
anti-government attitudes: some called it ‘the freest economy in the world.”
However, as our report explains, all the evidence suggests that Hong Kong’s
financial success stems ultimately not from this, but partly from the fact of
its world-class port geography and, more importantly, its partly-in, partly-out
relationship with China. At least on paper, Hong Kong accounted for just under
half of all foreign investment into China in 2011.
Hong Kong’s secrecy score of 72 places puts it at the higher end of
the secrecy scale, roughly on a par with Panama and Singapore. It offers a wide
range of offshore services including tax exemptions, transfer pricing
facilities, escape routes from Chinese exchange controls, and various forms of
financial secrecy including the use of opaque companies and trusts that can
assist tax evasion and other crimes.
The colonial roots of an
Hong Kong was created in 1842 after Chinese rulers sought to crack
down on the trade in opium,
which British traders were then pushing hard into the Chinese market, even
though it was banned. In response to the Chinese crackdown Britain sent a naval
fleet which killed some 20,000 people and shattered the Chinese Empire, leading
to the Treaty of Nanking in 1842 under which China ceded Hong Kong to Britain.
From these ignoble beginnings the territory became Britain’s commercial gateway
Along with shipping and general trading, finance was a central
ingredient of Hong Kong’s economic success from the outset - and was also a pillar
of British policy towards China, anchored in a collaboration between the
Foreign Office and the Hong Kong-based Hong Kong and Shanghai Bank, the
forerunner of today’s HSBC[ii].
In the 19th Century and for much of 20th
Century, the “difficult” Chinese market never turned out to be the fabled
source of riches that many British financiers had hoped, and even the City of
London’s limited role in funding Chinese infrastructure nurtured considerable resentment.
As one Chinese revolutionary leader said in 1910 (ibid p441)
“If [China] is not conquered by partition it will be lost by invisible
financial control by foreign powers.” After the Chinese revolution of 1911
China turned inwards, and although the turmoil did divert some trade to the
relative stability of British Hong Kong, British opportunities were somewhat
meagre. However the subsequent Chinese civil war of 1945-49 saw a new influx of
Chinese refugees and capital to Hong Kong, setting the stage for rapid industrialisation.
Laissez-faire Hong Kong
versus statist Singapore
As in many secrecy jurisdictions, British administrators in Hong
Kong espoused a strong, and at times almost extremist, approach to laissez-faire capitalism and consequent
high degree of tolerance for smuggling and other illegal commercial activities.
This overall laissez-faire approach
set the tone for future economic developments until today. In the 1860s Britain’s Jardine Matheson and
other trading houses even protested in London at British efforts to help the
weakened Chinese state collect taxes; the Hong Kong government, for its part,
wouldn’t co-operate with the Chinese either.[iii]
A century later Sir John Cowperthwaite, Hong Kong’s Financial
Secretary from 1961-1971, had such stridently anti-government views that he
even refused to collect official
statistics for fear they would give government officials too much power. The
economist Milton Friedman declared his love for Hong Kong’s freewheeling
free-marketism and cited this – as many have done since – as a key reason for the
territory’s undoubted economic success over the decades. Yet all the evidence strongly
suggests otherwise for two big reasons: first, the reasons for Hong Kong’s
success lie elsewhere, and, second, it was never the free-market economy that that
its cheerleaders claim.
Hong Kong has been an exception to a fast-growing Asian region
characterised by heavily state-led industrialisation. The comparison with Singapore is particularly instructive
here. The former Singaporean premier Lee Kuan Yew who visited Hong Kong
regularly (From Third World to First: The
Singapore Story: 1965-2000, p605)
summarised the very different approaches:
“In Hong Kong what is not expressly
forbidden is permitted; in Singapore, what is not expressly permitted is
This underpinned very different economic and social policies, as Lee
“The few trade unions they had did not
fight market forces . . . There was no
social contract between the colonial government and [Hong Kong’s people.]
Unlike Singaporeans they could not and did not defend themselves or their
collective interests. They were not a nation – indeed, were not allowed to
become a nation. China would not have permitted it, and the British never tried
Joe Studwell, founder of the China Economic Quarterly, summarises
what is perhaps the core reason for both Hong Kong’s and Singapore’s success,
and is worth quoting at length:
“As relatively easily managed city states, Hong Kong and Singapore
perform a simple economic trick: they arbitrage the relative economic
inefficiency of their hinterlands . . .
Since colonial inception they have offered tariff-free trade (with few or no
questions asked about where the money came from) . . . the regional offshore
roles of Hong Kong and Singapore have been absolute constants since their
founding, and show no sign of change.”[iv]
Hong Kong’s immediate
hinterland is Southern China, though the closing of the mainland to most trade
between 1949 and 1979 also made the city focus more than it otherwise would
have on business with southeast Asia, giving it a broader regional and
international spread. Studwell continues:
Under Mr. Lee – who never much liked private businessmen – Singapore
followed a statist model, with the government taking public control of most
significant companies. Hong Kong pursued an apparently opposite free market
. . .
At the end of the 20th Century, the result of ostensibly
diametrically opposite approaches to economic management was GDP per capita in
the two cities that varied by less than $1,000. The lesson? That a city state
with a strategic deep water port in a region that has relatively higher levels
of mismanagement, corruption and political uncertainty will prosper, with
little reference to official economic philosophy.
. . .
Hong Kong and Singapore were destined to succeed. All they had to do was to be
one degree more efficient, one degree more attractive to capital than
In practice, Hong Kong was never a
free-marketeer’s paradise. As historian Catherine Schenck notes, large
public subsidies for housing and education meant that “the reality was very different from the myth of complete
laissez-faire.” Vital sectors such as land ownership are carved up, often
through monolithic cross-sector corporate entities. In the ports, for example,
container handling fees are among the world’s highest, despite low labour costs[vi].
Hong Kong does not even have a functioning competition law – and the first ever
legislation on this, due to take effect in
2014, are full of exemptions. Hong Kong always was and is today, as
Studwell put it, “a patchwork of de facto
cartels,” whose roots lie in the colonial era. Historian Steven Tsang explained
that behind the scenes,
remained the largest employer, the biggest developer of real estate, the
leading constructor, the largest landlord, and the biggest provider of health
and education services.”
As a (more polemical) account puts it:
mistook Hong Kong's colonial economic system as a free market, despite Hong
Kong's highly orchestrated colonial command economy.
. . .
Even during the best of times, the average local Chinese small and medium
businesses had to operate under the dictates of British colonial policy and at
the mercy of monopolistic British trading firms and banks, not to mention that the
average worker never had it good at all. British monopolies needed an
unregulated supply network of ruthless predatory competition to keep costs low.
. . .
The so-called rule of law, so frequently touted these post-colonial days in
Hong Kong, merely meant that no local Chinese business ever won a case against
any British trading firm in 150 years of colonial justice.”
This goes a long way towards explaining how
Hong Kong’s great per capita wealth masks vast economic inequalities and
outright poverty, as the subsequent sections show.
The Open Door, then the
China’s Open Door policy announced by Deng Xiaoping in 1978 opened
the way for Hong Kong to emerge as a modern financial centre and secrecy
jurisdiction. Visible trade grew by an astonishing 28 percent per year from
1978-1997, according to Schenck, and by
the time of the British handover in 1997 an estimated 80 percent of foreign
investment in China’s rapidly industrialising Guangdong province was at least nominally from Hong Kong.
Long before the handover in 1997, Britain began to consult and
negotiate policy changes with China in what was known locally as a “through
train”, to ensure continuity. Britain hoped this, and the fact of Hong Kong’s
legal system based on English common law, would help City of London financial
interests retain the historical foothold they had always maintained in this
gateway to China; and the City has had significant successes in this respect:
today about half of all foreign financial claims on Hong Kong are
from British banks.
When the handover came Hong Kong was given a wide degree of autonomy
under its Basic
Law, but with China taking over responsibility for defence and foreign
relations, and gaining powers to appoint Hong Kong’s chief executive and top
officials. This set-up is remarkably similar to the arrangements that Britain
has with its Crown Dependencies and Overseas Territories, most of which are
secrecy jurisdictions: Britain also retains responsibility for defence and
foreign relations, and appoints top officials. This very close similarity is no
coincidence, given the history – China’s competences today are roughly the same
as those held by Britain – and the Chinese leadership’s personal incentives with
respect to Hong Kong certainly helped smooth the handover.
Hong Kong was always intended as a familiar, trusted and partly
controlled offshore centre for the Chinese leadership and wider élites: a place
where business can be conducted in a familiar, proximate and Chinese-speaking
environment, but also significantly protected from mainland scrutiny. For added
secrecy, Hong Kong structures are often combined with structures in other
jurisdictions outside the Chinese orbit, particularly the British
Virgin Islands. It is hardly surprising that Hong Kong has served as the
prime turntable for Chinese bribery and other corrupt activities.
Hong Kong today: round
tripping, trusts, and other offshore offerings
Hong Kong has for years served
as a major ‘round tripping’ turntable for China and other countries. Round
tripping involves Chinese investors shifting their money to Hong Kong, dressing
it up in offshore secrecy, then returning it to China masquerading (illegally)
as foreign investment, in order to obtain special privileges afforded to
foreigners. The Asian Development Bank remarked
in 2004 that “the scale of round tripping FDI in PRC [China] is very large” and
the State Administration of Foreign Enterprises (SAFE) admitted
recently that mainlanders, not foreigners, were very significantly behind
the flow of speculative ‘hot money’ into China.
Round tripping activity largely explains the fact that of the total
$1.9 trillion in nominal inward investment into China in 2011, over $850
sourced (nominally) from Hong Kong. To
put that $850 billion into perspective, it is 15 times the size of the $55
billion in recorded direct U.S. investment into China, but much of the
investment originating from the US is also likely to be Chinese origin capital,
routed via family links within the US-Chinese diaspora. As scholars have
noted: “the great majority of foreign direct investment
in China has come from the Chinese diaspora.” The
second largest ‘investor’ in China by far - at $298 billion - was the British
Virgin Islands. Not only that, but large-scale illicit capital flows are
attracted to Hong Kong from other developing countries, particularly those with
increasing commercial ties to China.
Hong Kong hosts a range of sectors and intermediaries catering to
offshore activities. Private banking, strongly reliant on secrecy, is among the
most important. Since 2009, when G20 leaders declared that the “the era of
banking secrecy is over” and promised a crackdown on secrecy (though relatively little
has been delivered, to date) there has also been a significant displacement of
corrupt, criminal and other abusive financial activities, both in terms of
assets and also of the structures holding those assets – away from Western
centres and towards Asian tax havens, notably to Singapore and Hong Kong. Hong
Kong held nearly US$300bn in private banking assets in
2010, though this was eclipsed by Singapore’s $500 bn. While these two
secrecy jurisdictions are growing very fast, this activity is still eclipsed by
Switzerland’s private banking sector, with over $2.2 trillion in assets under
There is also a large trust
administration industry in Hong Kong – an estimated HKD2.6 trillion
held by Hong Kong trusts at the end of 2011 (around half the size of assets
managed in the British tax haven of Jersey.) Hong Kong’s Trust Law (Amendment)
bill of 2013, while modernising the laws and making some improvements, also gives
enhanced powers to settlors of trusts, which could create greater possibility
for abuse by allowing them to pretend to give away assets (and thus creating an
impenetrable secrecy wall) while still retaining a large degree of control.
Beyond secrecy, Hong Kong offers a range of other ‘offshore’
attractions, notably in the areas of tax and financial regulation. In 2009
China launched a pilot scheme in Hong Kong for the settlement of trade in
Renminbi, rather than the U.S. dollar, first steps towards an eventual goal of
seeing the Renminbi as a global reserve currency: a matter of potentially
profound geo-strategic importance[vii].
The market has grown significantly: the share of Chinese trade settled in
from less than one percent in 2010 to 12
percent in 2013. In September 2011 China and the UK agreed
to start developing the City of London, via its age-old Hong Kong links, as
another offshore Renminbi trading centre; by September 2013 nearly
a third of offshore Renminbi transactions were conducted in London.
Tax is another powerful component of Hong Kong’s offshore offering. Hong
Kong does not tax capital gains, dividends or deposit interest, and has no
inheritance taxes. In common with many secrecy jurisdictions, it adopts a
‘territorial’ principle which only taxes income arising in Hong Kong - while
profits from overseas trading operations accruing to Hong Kong wealth managers
are generally not taxed. Hong Kong is widely used as a base for transfer
mispricing, where corporations shift profits offshore to escape tax.
As our database reports shows, Hong Kong has made some limited efforts
to curb its worst secrecy excesses, in line with changing international norms, though
its secrecy score has changed relatively little, from 73 in our last index in 2011
to 72 in 2013. China’s dominant political position has enabled Hong Kong, to a
greater degree than many other jurisdictions, to withstand international
pressures for transparency.
The Financial Action Task Force reported on
secrecy in 2012:
Kong has a workable and fairly comprehensive criminal confiscation regime, these
measures are not available in all cases, do not extend to all predicate offences
and the number of confiscations is relatively low. While legislative provisions
have been enacted for confiscation of the proceeds of Tax Fraud, these
provisions are not yet in force. [...] The preventive system for some non-core
financial institutions does not incorporate adequate customer due diligence
(CDD) requirements with respect to politically exposed persons.”
Hong Kong: a lopsided
These offshore offerings have certainly
drawn large amounts of wealth to Hong Kong from elsewhere, and the territory
does enjoy very high per capita incomes relative to others in the region.
However, this is not the end of the story, as the Financial Times notes:
“There is a
growing perception that Hong Kong’s free market model is designed to benefit
the wealthy. The city has the worst income disparity of all developed
economies, according to a UN report, and one in five households lives below the
According to the Boston Consulting Group,
Hong Kong now has the world’s highest density of billionaire households, at 15
per million – while median incomes have reportedly stagnated
since at least 1999. This has happened while manufacturing, which began to
plateau in about 1990, was eclipsed by a large growth in finance and services:
from 1980-1997 employment in manufacturing share fell
from 46 percent of total employment to just under ten percent. It seems likely
that this dramatic fall is partly the result of ‘finance
curse’ factors we have identified in other jurisdictions.
But perhaps the major reason for such
extremes of wealth is the high ongoing cartelisation of the economy, as described
above. One account,
looking at rising protests in Hong Kong amid stagnant median incomes, summarises
the underlying economic structure:
“a handful of
the richest families hold monopolies and duopolies on everything from
supermarket chains and property developments to public transportation systems,
electricity providers and public service companies.”
economic success is certainly real – but it is not at all what it seems.
Studwell, Joe, Asian
Godfathers: Money and Power in Hong Kong and southeast Asia, Atlantic
Monthly Press, 2007
Cain, P.J and Hopkins (1993), A.G, British Imperialism: Innovation and Expansion 1688-1914, Longman
Lee, K.Y (2000), From Third World to First: The Singapore
Story: 1965-2000, Harper: New York.
[i] For instance, when the OECD sought to prepare a ‘blacklist’ of tax
havens in April 2009 at a G20 summit meeting in April 2009, Chinese Premier Hu
hard behind the scenes – successfully – to keep Hong Kong and Macau, a much
smaller Chinese-linked haven, off the OECD blacklist.
[ii] See British Imperialism:
Innovation and Expansion 1688-1914, the historians P.J. Cain and A.G.
A loan to China’s Ch’ing dynasty in 1874 - the first ever foreign loan issued
to China - helped cement the bank and Hong Kong as the key links between China
and the City of London.
[iv] Joe Studwell, Asian
Godfathers: money and power in Hong Kong and South East Asia, Atlantic
Monthly Press, 2007, pp33-34
[vii] This new development in Hong Kong partly mirrors the period of the
1960s and 1970s, when the United States tolerated the existence of the
fast-growing offshore “Eurodollar” market, partly because of its role in internationalising the
U.S. dollar and cementing its status as a global reserve currency, allowing the
United States to (among other things) fight the Vietnam war without having to
worry about paying for it immediately.