(Bloomberg) — Donald Tsang, consider yourself shanghaied.
It happened on March 5, as Hong Kong's chief executive visited Beijing. There, local media confronted Tsang with a Bloomberg News article pointing out that Shanghai's economy exceeded the size of Hong Kong's for the first time in at least three decades.
Tsang's retort was predictable: Shanghai's rise is "not a threat." Here is mine: Who are you kidding?
For years now, Hong Kong has argued the city's uniqueness enshrined its prosperity. Its rule of law, economic freedoms and role as the gateway to China have trumped concerns such as long- term relevance and bad air quality. Also, investors haven't made lots of money betting against Hong Kong.
Yet the day Hong Kong has long pooh-poohed is here. Shanghai is rapidly regaining its position as China's dominant financial center. And investors betting on Hong Kong's once- indisputable place in Asia should think again.
Financial Secretary John Tsang said last week that Hong Kong is at the early stage of a recovery. Its economy is growing at about 2.6 percent — not bad in a global context. The problem is the longer-term picture.
Here, Forbes magazine's latest billionaires list is worth considering. The headlines in Asia focused on "Superman." That would be Li Ka-shing, whose fortune jumped 30 percent to $21 billion over the last year. It was deemed good news; Li is often portrayed as personifying Hong Kong's ups and downs.
The real story, though, was the wealth boom on the mainland. For the first time, mainland China has the most billionaires outside the U.S.
Perhaps that's as it should be, given China's 1.3 billion- person population. A similar argument can be made about gross domestic product. Shanghai has about 19 million people to Hong Kong's 7 million. According to 2008 figures, Hong Kong's per- capita GDP is $30,977; Shanghai's is $10,713.
Yet the trajectory is clear. Even if China grows more slowly in the next few years, its need for a middleman economy like Hong Kong's is dwindling. Shanghai is now China's biggest port and stock-market operator.
HSBC Holdings Plc, Europe's biggest bank, may soon be the first foreign company to list in Shanghai. Policy makers there are wooing more overseas issuers seduced by China's potential. That dynamic is likely to siphon off capital that might otherwise gravitate to Hong Kong.
Hong Kong's Role
Really, how much longer will bankers, investors and corporate executives feel the need to stop by Hong Kong on the way to China? Over time, going directly to the source of demand makes far more sense.
As more and more buildings appear in China, there may be less support for Hong Kong's all-important real-estate market. Economic growth might become more restrained and the city's credit rating could easily take a long-term hit.
There are, of course, reasons to hedge one's bets on China. Overheating risks abound as officials in Beijing grapple with the biggest increases in consumer prices in 16 months. Real interest rates are now negative, something that may skew incentives to spending. As household savings are eroded, consumers may react by purchasing property and stocks. The result could be new bubbles.
China's currency is another impediment. Until the yuan is fully convertible, its international use will be limited. For many, that leaves Hong Kong serving as a test bed for such transactions. The city ranked No. 3, compared with Shanghai's 10th place, in the September Global Financial Centers Index, compiled by consultants Z/Yen Group.
Shanghai's day is coming faster than many appreciate. It surpassed Hong Kong seven years earlier than projected by the government-backed Hong Kong Trade Development Council in a 2001 report. As Shanghai replicates Hong Kong's strengths, Hong Kong will only become less relevant.
It's not just Shanghai, but also Shenzhen. Sitting just north of Hong Kong, the booming city's population is already bigger. The skyscraper-strewn city is attracting capital that a couple of years ago might have gone to Hong Kong. And this forgets the several other cities dotted around China looking to become the next Shanghai or Shenzhen.
If there's a silver lining here it's the catalyst effect. Shanghai makes it harder for Hong Kong to continue resting on its laurels. It's no longer enough to rely on the arts and theme parks such as Disneyland and Ocean Park to boost growth. Walt Disney Co., by the way, is now moving into Shanghai.
A better idea would be to empower entrepreneurs who will not only create jobs but bring more buzz. Each year, the Heritage Foundation and the Wall Street Journal, which publish the annual Index of Economic Freedom, rank Hong Kong as the freest economy — perfect conditions for such entrepreneurs.
True, the city features the free entry of foreign capital, a first-world legal system and low taxes. It's also an economy of oligarchs; a handful of tycoons tower over it. Their dominance sucks up much of the innovative oxygen that could enliven the bottom half of the economy.
Unless China falters, Shanghai will be a growing problem for Hong Kong. That should concern investors betting on the city's future.
To contact the writer of this column: William Pesek in Tokyo at firstname.lastname@example.org