Special Report on Hong Kong: Taming the 'wild-west' territory: The colony faces a trade dilemma as 1997 looms, writes Philip Bowring

MOST PEOPLE in Hong Kong regard the increasingly close links between its own economy and that across the border as one of its greatest strengths, as well as one which will ease its tran sition to the post-1997 political future. The relationship is a complex one, however, and it has yet to be shown conclusively that Hong Kong will do better by turning inward to a fast- growing but still backward China than by concentrating on its traditional role as a regional and international centre.

Hong Kong and Taiwan people can reasonably claim to have created the south China export boom from which has flowed so much of China's new confidence and its conversion to the notion of a 'socialist market economy', whatever that may be. Their manufacturing abilities, marketing networks and entrepreneurial talents were far more important than their capital.

There is scant sign yet of a mainland class which could take their place. What started as a tentative movement of labour- intensive factories into the Shenzhen Special Economic Zone adjoining Hong Kong became a flood to development areas in Guangdong and Fujian provinces. All offer similar - and generous - tax incentives for export industries. Differences between the zones lie mainly in land and labour costs, which in turn relate to proximity to transport and services.

The line between foreign and domestic trade and investment has blurred as export manufacturers gain access to local markets and as the Hong Kong currency is increasingly used in transactions in Guangdong and mainland banks will make Hong Kong dollar denominated loans for property investment by Hong Kong people in China. Mainland state entities have also converted themselves into 'foreign' companies via Hong Kong to take advantage of tax breaks for foreign investors in China.

None the less, neither the importance nor similarity of Hong Kong to its neighbour should be exaggerated. Though Hong Kong and Taiwan investors have provided the development spur for Guangdong, and though Hong Kong and Shenzhen are meccas for the new mainland fat cats, Hong Kong's population is but one tenth of Guangdong's total. And, for all their energy, Shenzhen and the other development zones are wild-west territory, where corruption is rife at official levels.

Nothing better illustrates this than the flow of stolen luxury cars from Hong Kong across the border. Although Hong Kong- origin cars are easily distinguishable by their right-hand drive, mainland officials are quite brazen in their use of obviously stolen property.

Guangdong's 15 per cent annual growth rates are, for the time being, more than enough to offset such minor drawbacks. But they do suggest long-term problems for Hong Kong. One is the threat to China's Most Favoured Nation (MFN) trading status with the US. Transferring to a cheap labour location has helped profits enormously but left Hong Kong manufacturers hostage to US-China relations in a way that local manufacture never was. So long as China remains a largely closed market, outside Gatt and with a rigged currency rate, Hong Kong will be vulnerable.

It is hard to estimate the impact of the loss of MFN privileges. Many Hong Kong manufacturers only use China for part of their operations, and thus their exports count as being from Hong Kong rather than China. Alternatively, Hong Kong could be more badly hit by China imposing tight import restrictions or effective restraints on capital outflow.

Either way, Hong Kong cannot ignore the fact that just as it has benefited from the recent China boom, so it could suffer from a bust. A decade ago, re- exports (mostly to and from China) accounted for only one- third of total exports. Two- thirds were domestically manufactured. Now less than a quarter of exports are locally made. That may not be unreasonable. City states are more naturally service than manufacturing centres. But the dependence on China trade has become heavy, at the expense not just of older relations with the West but also of other east Asian relationships.

In the longer term, closer relations across the border also suggest that land and labour prices may begin to converge. That could just mean those in Guangdong will rise.

After 1997 there could be strong pressure to reduce the barriers to movement into Hong Kong - just as the mainland authorities have turned a blind eye to massive 'illegal' immigration in Shenzhen. Should the lawless ways of Shenzhen combine with the political imperatives of Peking, some of the highest value added business - the international banking and sophisticated services - might be scared out of Hong Kong.

The city's post-1997 prosperity may be assured. But is that prosperity to be one defined by the standards of the rest of China, or the rest of east Asia?