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The rise in domestic inflation and production costs will slowly erode the real competitive advantage which the current nominal level of link to the US$ represents. However, there is evidence that exporters are sacrificing profit margins to volume and market share by holding export prices down. In any case the high growth rate of exports suggests that more rapid HK inflation could persist for some time before the current competitive edge is blunted.
Domestic cost pressures are likely to lead to a greater use of low-cost mainland labour for simple processing tasks. The Territory would then increasingly specialise in higher value-added,
skill-intensive production, and the design, marketing and financial services related to production within China. This clearly has benefits for both the mainland and Hong Kong.
20. With the increases in overtime already having taken place constraints of labour and capacity utilisation are likely to slow down the possible rate of growth of production and exports. Production in China is one way of easing these domestic constraints, as is the increased emphasis on investment to increase automation.
21. It is the flexibility of the economy in responding to such problems that will determine the medium term outlook. The nominal exchange rate is to be preserved in the interests of political confidence, and the small size of the public sector leaves little role for discretionary fiscal policy. It does not appear that current inflationary pressures are out of hand (though another speculative boom and bust in the property sector would be extremely unwelcome) and the immediate prospects are encouraging.
Nick Hallett.
N O Hallett
Economic Advisers WH 426B
270-2727
10 September 1987