China has demonstrated it is eager to follow through on the financial cost of suppressing Hong Kong

Last week, the Chinese government passed a broad national security law criminalising dissent in Hong Kong. While the law has already had a chilling effect on protests, the consequences for Hong Kong’s economy are unclear. Since 1 July, Hong Kong’s stock market has climbed. Some foreign businessmen in Hong Kong have dismissed the law’s potential effect on business. This incredulity is unsurprising: for decades Hong Kong has thrived as a gateway for international capital into and out of China. Surely Beijing wouldn’t kill its own “golden goose”?

But investors and businessmen, used to the unencumbered movement of capital, may have lost sight of recent changes. Contemporary China is different today to just 10 years ago, let alone to the 1990s when Hong Kong was handed over by the British. Now a global power that commands one-sixth of the world’s GDP and is increasingly authoritarian, it is approaching Hong Kong with a new rationale that is both political and economic.

Hong Kong became an economic marvel because of its unique position between China and the world. From the 1940s, when it benefited from an influx of mainland-Chinese refugees, its colonial government ran a liberalised economy with loose capital controls and low tariffs. When foreign investment began to pour into China in the 1990s and 2000s, Hong Kong investment banks, law firms, real estate companies and other professional services served as their intermediaries. At handover in 1997, Hong Kong accounted for 80% of foreign direct investment (FDI) into nearby Guangdong province. In 2018, Hong Kong was responsible for a staggeringly high 60% of overall FDI flowing in and out of China.

Economies like Hong Kong’s are designed to attract international capital through deliberate free-market policies, often at the expense of local labour laws, wealth equality and environmental protections. Beijing understood in 1997 that Hong Kong occupied a critical role in China’s process of economic transformation – it allowed for an easier navigation of its less capital-friendly economy, which still bore elements of central planning. Today, Hong Kong also serves as a vital conduit to Chinese capital seeking investments abroad.

However, the new security law signals a change in thinking. The law can be broadly applied to a range of activities, not just protests. Whereas past actions from Beijing chipped away at Hong Kong’s “One country, two systems” institutions, such as education, free elections and an independent judiciary, the security law eliminates free-speech protections, inserts political bodies as lawmaking authorities and grants police authority without judicial oversight, thus dismantling wholesale the legal institutions that previously insulated Hong Kong from its control.

The neoliberal economic policies of the 20th century were partly made possible by the creation of legal and economic institutions that protected markets from state intervention. While certain economic policies are still intact in Hong Kong, such as the lack of capital controls, the dismantling of the separate legal institutions opens the door for the erosion of market protections that capitalism depends upon. For investors to feel reassured, they need to be reasonably certain politics will not interfere with profit. Capitalists can feel secure if the authorities violently crack down on protesters disrupting streets, public transportation and airports. Indeed, docile labour is one of the many hallmarks of authoritarian capitalist regimes that are so attractive to western investors. But capitalists can also flee if a lack of judicial oversight creates the space for state intervention in transactions or the censuring of businesses deemed politically threatening.

Put bluntly, the law signals that Beijing sees quelling dissent as important enough to risk Hong Kong’s legal and economic institutions. This plays into a longer story. In its Belt and Road Initiative, a global infrastructure programme launched in 2013 and targeted at the global south, Beijing deploys a form of state capital that is designed to achieve diplomatic rather than purely economic objectives. At home, China has become increasingly authoritarian in response to perceived threats, best exemplified by the forced detention of Uighur minorities in Xinjiang. As the Hong Kong protests snowballed into a greater threat to its legitimacy, Beijing weighed its own regime’s security against the possibility of economic fallout from neutering Hong Kong. It chose politics over economics.

But these two may not even be mutually exclusive in the long run. In the PRC’s authoritarian capitalist system, both can thrive. Since the 1990s, FDI into China has become more diffuse. Provincial and local level governments often directly negotiate with foreign and domestic investors, instead of through Hong Kong-based intermediaries. More investment banks, law firms, and other multinational corporations have expanded or moved regional headquarters to Shanghai, whose GDP surpassed Hong Kong’s in 2011. Shanghai and Shenzhen have their own stock exchanges and, along with Beijing, these cities have built up the financial, insurance and real estate expertise needed for international transactions. If Hong Kong loses its legal and economic institutions, then foreign investors can skip straight to Shanghai, Shenzhen and Beijing. Moreover, these are places that the regime has full control over, and less likely to be the site of mass protests.

It is difficult to predict how financial markets and capital flows will respond to ongoing political changes in Hong Kong in the long run. Investors will not abandon Hong Kong in the short term, especially as they are preoccupied with Covid-19. Still, the important takeaway is that Beijing is willing to pay the economic cost of this political battle. And this has implications for Hong Kong’s democracy movement, too – if the security law causes the territory’s economic power to wane, so too does its citizens’ leverage. Disrupting business in Hong Kong through protests will have less impact if, several decades from now, Shanghai has eclipsed Hong Kong as the financial centre of China. In such a scenario, the greatest loss would be for the city’s citizens, who are fighting for their identities and livelihoods.