Managed in hong kong adaptive systems, entrepreneurship and human resources

Edited by Paul Stewart Management in China: The Experience of Foreign Businesses Edited by Roger Strange Human Resource Management in the Asia Pacific Region: Convergence Questioned Ed

Adaptive Systems, Entrepreneurship and Human Resources

1369-7153

Editors: Robert Fitzgerald, Chris Rowley and Paul Stewart

Greater China: Political Economy, Inward Investment and Business Culture

Edited by Chris Rowley and Mark Lewis Beyond Japanese Management: The End of Modern Times?

Edited by Paul Stewart Management in China: The Experience of Foreign Businesses

Edited by Roger Strange Human Resource Management in the Asia Pacific Region:

Convergence Questioned Edited by Chris Rowley Korean Businesses: Internal and External Industrialization Edited by Chris Rowley and Johngseok Bae

China's Managerial Revolution Edited by Malcolm Warner East Asian Direct Investment in Britain Edited by Philip Garrahan and John Ritchie

Managed in Hong Kong: Adaptive Systems, Entrepreneurship and

Human Resources Edited by Chris Rowley and Robert Fitzgerald

MANAGED IN

HONG KONG

Adaptive Systems, Entrepreneurship

and Human Resources

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Managed in Hong Kong: adaptive systems, entepreneurship

and human resources - (Studies in Asia Pacific business;

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1 Business China Hong Kong 2 Personnel management China - Hong Kong 3 China - Economic conditions - 1976-

-I Rowley, Chris, I-I Fitzgerald, Robert,

1959-III Asia Pacific Business Review

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Managed in Hong Kong: adaptive systems, entrepreneurship,

and human resources / editors: Chris Rowley, Robert Fitzgerald

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Includes bibliographical references and index

1 Industrial management-China-Hong Kong

I Rowley, Chris, II Fitzgerald, Robert,

1959-Ill Series

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This group of studies first appeared in a special issue of

Asia Pacific Business Review [ISSN 1360-2381] Vol 6, No.1 (Autumn 1999)

published by Frank Casso

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Managed in Hong Kong: Economic

Development, Competitiveness and

Deindustrialization

From Entrepot to Entrepot via

Merchant Manufacturing: Adaptive

Mechanisms, Organizational

Capabilities and the Structure of

the Hong Kong Economy

Hong Kong as a Complex Adaptive

System

The Demand for Business and

Management Education in

Hong Kong beyond 1997

The Generation of Organizational

Management Practices between MAY M.L WONG and

Hong Kong's Development:

Prospects and Possibilities

To the memory of Celia Kenworthy: teacher, mentor, friend

1

Managed in Hong Kong:

Economic Development, Competitiveness

and Deindustrialization

CHRIS ROWLEY and ROBERT FITZGERALD

Hong Kong's successes are evident Hong Kong has achieved remarkable rates of gross domestic product (GDP) growth and improvements in living standards The World Bank (1994) reported that Hong Kong's GDP per capita grew in real terms at an annual rate of nearly 6.5 per cent between 1965 and 1989 The trend is noteworthy because of its relative scale and duration - though it was not unprecedented - and because Hong Kong was an important part of an economically dynamic region The same report noted that life expectancy, 64 years in 1960, had grown to

78 by 1990, and ranked Hong Kong amongst the wealthiest economies Like its parallel city-state Singapore, Hong Kong enjoyed a high GDP per capita, its US$ 22,900 in 1995 being higher than the OECD average (Thompson, 1998).1 In 1997, its 5.5 million people living in an area of just 1,096 square kilometres produced a total GDP of US$ 171.9 billion, with a real GDP growth (annual percentage change) of 5.2 per cent, and

unemployment of just 2.4 per cent of the workforce (Financial

Times, 1998) Nevertheless, for all of Hong Kong's vaunted

performance, vulnerabilities remained Furthermore, fresh ones have recently emerged - property prices and the stock market have witnessed sharp fluctuations, unemployment has risen, and GDp, consumption, government spending and exports have all been affected

As ever, the interpretation of this phenomenon at the level of politics, culture, human capital and business organization is less obvious Asian economic dynamism has attracted the attention of numerous researchers, business people and policy-makers, often in search of a 'magic elixir' to be injected into other economies Recent unification with the People's Republic of Chinaz has also

Chris Rowley, City University Business School, London; Robert Fitzgerald, Royal Holloway, University of London

stimulated interest in Hong Kong and its economic achievements (see, inter alia, Ng and Lethbridge, 1995; Mole, 1996; Berger and Lester, 1997; Enright et al., 1997) The 'usual suspect' list of 'explanations' for Hong Kong's emergence and development has been established Amongst the factors often touted are so-called 'Asian values', culture and guanxi, leading to an emphasis on the work ethic, thrift, family loyalty, personal discipline and self-reliance Likewise, the central role of small family businesses and even of young, cheap and 'docile' women workers in light manufacturing industries (CAW, 1995) are familiar These attributes have seemingly been supported and encouraged by a regime of 'freewheeling' capitalism and unfettered market forces, though a more intricate assessment of economic structure, industri-alization and the system's main actors - state, employers and employees - is available (see, inter alia, Wilkinson, 1994; Rowley and Lewis, 1996) Hong Kong's nodal position along trade routes, its ability to attract capital and entrepreneurs, and its role as gateway to mainland China have also formed important components of the 'explanation'

As the contributors in this volume make clear, Hong Kong now faces new and renewed challenges which are linked to shifts in the industrial structure, emerging market demands and the inter-connected upgrading of both production and human resources, in addition to the implications of reunification They examine and analyse aspects of Hong Kong and its performance, which range from its systemic 'adaptability' and 'complex adaptiveness' through

to more specific detail on contrasting human resource management practices, education and training, and cross-cultural variations in the generation and meanings of organizational commitment Key themes of national competitiveness, deindustrialization and the upgrading of production facilities and human resources are all shown to be important, but also multi-layered and hazy concepts (see also Rowley, 1998a; Ng and Poon, 1998; Poon, 1995)

NATIONAL COMPETITIVENESS

Hong Kong is still frequently labelled 'competitive' It was recently ranked as the second most 'competitive' economy by one research institute (World Economic Forum, 1998) Definitions of

'competitiveness', particularly when the term is applied to national economies, present numerous difficulties Krugman (1994a) believes that the concept is meaningless when attached to nations

or whole economies, which do not go bankrupt, can use exchange rates to adjust the terms of trade, and vary in the degree to which they trade in goods and services (see also Oxford Review of Economic Policy, 1996; Boltho, 1996) As Ricardo famously observed, international trade is not a zero-sum game of winners and losers Furthermore, the larger proportion of national productivity rises - the cornerstone of living standards and the very point of 'competitiveness' - is rooted in domestic not external circumstances (Krugman, 1996) That said, Hong Kong is a markedly open trading economy, and the organizational structures and their networks which emerged in the post-war period produced a set of possible capabilities or competitive advantages suited to its limited choice of opportunities

Our appraisal of the competitiveness and transformation so evident in East Asia and Hong Kong has undoubtedly been influenced by the region's contemporary turmoil, and it is impossible to predict the outcome of these events The advantages

of certain values and systems now seem undermined by revelations

of speculative investments, non-accountability, personal favouritism, indebtedness, and the collapse of domestic and overseas markets Erupting difficulties seemingly add weight to sceptical assessments of economic growth in Asia Using the calculations of Young (1994), Krugman (1994b) views the region's growth cautiously, mainly attributing its speed to increased inputs

of labour, capital and raw materials It follows that productivity changes which occur through developments in technology, human skills, institutions and infrastructure were too limited and shallow Young's calculations and methodological approach to Total Factor Productivity (TFP) have been criticised, and other figures demonstrating the impact of productivity growth are available (World Bank, 1994: 46-75; see also World Bank, 1991) In any case, even Young's (1994: 970) results show Hong Kong achieving the sixth highest annual growth rate in TFP between 1970 and

1985 Living standards have risen significantly in Hong Kong, and this achievement, as our contributors argue, is related to human-based capabilities in entrepreneurship, business networks and the flexible organization of production These attributes have built upon Hong Kong's natural advantages

Some key points and factors need to be noted here concerning Hong Kong's particular economic structure and organization, because these helped to generate growth in the past and many are seen as inhibitors of further development Historically, the small colony of Hong Kong was economically sensitive to external shocks, including migrants escaping the turmoil of the mainland, and the suspension of trade with China and its entrepot function during the Korean conflict of 1950-3 In these circumstances, one remaining option for Hong Kong was the export of manufactured goods, and this historical factor, along with limited capital, an abundance of labour, and distance from target markets, conditioned the organization and operation of the businesses that subsequently emerged Comparative advantages also built on a cultural preference for family business, opportunistic behaviour, fear of financial over-commitment, and network alliances Related infrastructure, transport and other service facilities contemporane-ously expanded in support of a rapidly growing manufacturing sector, enhancing Hong Kong's newly found competitiveness One major theme in this volume is the 'entrepreneurial adaptation mechanism' (see also Yu, 1998) outlined by Carney and Davis.3 These contributors contrast Hong Kong's flexibly constructed family business networks with deep managerial hierarchies seeking economies of scale and scope within large organizations In their analysis, Hong Kong's economic success was predicated on businesses that cumulatively acquired, at a turning-point in their history, capabilities suited to a specific economic position or stage of development Hong Kong's entrepreneurial adaptation mechanisms supported an export-orientated economy, with lead sectors in textiles, plastics and consumer electronics, in which price sensitivity, low technology, undeveloped skills, a lack of capital intensity, and product flexibility were all major features Carney and Davis note the key characteristics of the Hong Kong environment:

• small domestic market;

• distance (physical, cultural, linguistic) to world's major markets;

• Chinese culture (trust, organizational structures, authority, management);

• sensitivity to external shocks (altering market opportunities, resources);

• state policy (local and UK)

Similarly, Ellis highlights the 'signature qualities' of Hong Kong's 'complex adaptive system' (CAS) in its post-1945 development and transformation from just an entre pot The CAS is adaptive or self-organizing in the sense that agents learn about their environment through feedback and embed that learning by reorganizing the very systems in which they cohabit The characteristics of such signature qualities are:

• economic activity is rooted in a historical, social and political context;

• environmental disruptions conform to a 'punctuated equilibrium' pattern;

• as the economy becomes more complex, it passes through a series

of phase changes

Hong Kong's economy was not merely dominated by 'small' establishments,4 but these firms were structured and operated in a very particular fashion Those employing less than 50 workers accounted for 78.7 per cent of manufacturing establishments in

1961 (though this may be a similar situation for many economies), rising to 86.5 per cent in 1971 (Chan et al., 1995) As Carney and Davis usefully reiterate, small family businesses have characteristics that facilitated their success (but which more recently also acted as barriers to further developments) These include:

• restricted start-up capital leading to low capitalization, largely in the form of machinery, and initially family sourced;

• economic culture and limited alternatives encouraging family ownership and control, with authority reposed in one dominant executive;

• shallow, single phase operations using general purpose assets and little technical or managerial skill;

• cost leadership competition via availability of cheap labour intensively worked, creating easy market entry;

• imitation or product designs provided by customers, and lack of such capabilities;

• focus on lowest cost input procurement and order-taking;

• agglomeration and physical proximity, with rapid communication

of information flows on market opportunities, suppliers and buyers, assisting responsiveness to business environments and international markets;

• infrastructure allowing inputs to be imported cheaply and efficiently

While this structure helped forge Hong Kong's development, it

is not without critics Growth was 'driven not so much by increasing the sophistication of production as by making quick responses to changing demands in the world market through the continuous pursuit of flexible, labour-intensive production

strategy' (Chan et al., 1995: 39) As we have seen, this was the

result of the operating milieu within which firms existed While

undoubtedly enterprises of this nature, structure and modus

operandi furthered Hong Kong's past growth, it remains an open

question whether these same businesses can break free from the effects of 'path dependence' Businesses suited to an earlier competitive environment remain entrenched in their particular organization, structure and methods of competition Yet their location was not so constrained, and many manufacturers succumbed to the attractions of the nearby mainland This has resulted in a 'hollowing out' of Hong Kong's manufacturing capability, and deindustrialization is a major issue for analysis

TOWARDS DEINDUSTRIALIZATION?

This is an important, and long-standing, area of debate On one side there is a 'manufacturing matters' school of thought, along with a 'deindustrialization' debate and a 'crowding out' of manufacturing thesis (see Bacon and Eltis, 1978, 1996) This has been matched by the visionaries of one strand of the so-called 'post-industrial society' camp (Bell, 1974) The latter often argue that services are the main drivers of economies and will account for the vast bulk of jobs These are not particularly new contentions, but they remain hotly contested in terms of their importance to the economy, employment and 'quality' of jobs However, often there are overly deterministic, narrow and entrenched positions taken on these issues It is argued that manufacturing is critical to the economy and irreplaceable, and must at all costs continue at

previous levels This can be counterposed with an equally 'hard line' view of unimportant 'smoke stack' and 'sunset' manufacturing

in a post-industrial, service dominated nirvana

From the mid-1980s, Hong Kong witnessed a rapid decline in the role of its manufacturing Manufacturing's share of CDP dropped from 22.3 per cent in 1986 to 15.2 per cent in 1991,

while the contribution of the tertiary sector increased (Chan et at.,

1995) Over the same period, trading, restaurants and hotels rose from 21.3 per cent to 25.4 per cent of CDp, while the financial and business sector increased from 17.3 per cent to 22.7 per cent (ibid.) Such restructuring was partly a response to China's 'Open Door' policy from the late 1970s, as geographical proximity and abundant cheap labour attracted capital and production from Hong Kong As trade with the mainland expanded, Hong Kong began to return to its former role of an entrepot, as if closing a developmental cycle (see also Ng and Poon, 1998)

There was an even more pronounced shift in Hong Kong's employment patterns Manufacturing jobs declined from over one million in 1981 (41 per cent of the workforce) to 750,000 in 1990 (28 per cent) and to 595,000 by 1993, while service employment rose from 47 to 79 per cent of the total between 1981 and 1990

(Chan et at., 1995; Lee) However, the cyclical nature of these developments should be remembered Before the Second World War, manufacturing was not a significant part of the Hong Kong economy (see Ng and Poon, 1998) While manufacturing employment accounted for 47.7 per cent of the labour force in

1971, falling to 20 per cent by 1994, this was almost the same percentage as in 1931, when it was 19.2 per cent (see Ellis) In a broader context, there is no doubt that manufacturing provides fewer jobs than in the past in a range of economies For example,

in 1997 less than 1:6 workers were employed in manufacturing, the figure in the EU was 1:5, and even in Japan (often cited as an exemplar of a state that has fought to foster manufacturing) it was

less than 1:4 (Economist, 1997)

A common explanation for such trends is the migration of manufacturing jobs from 'richer' and more advanced economies to 'poorer' and less developed ones Yet, deindustrialization, or an expansion of the service sector, in Hong Kong presents a complex picture, as recent debates on sectoral shifts away from manufacturing have illustrated (Aarnio and Rowley, 1996) There

are problems of definition, and many companies combine both activities Other causes of 'hollowing out' are beyond this analysis, other than to note that it could be due, in part, to the following

(Economist, 1997) First, official figures and classifications could

exaggerate changes For instance, business practices, such as subcontracting out aspects of work, can have an impact Thus, manufacturing firms that used to employ cleaners, security and even personnel specialists can now hire those from the outside, so their jobs are reclassified as part of the service sector Second, a 'consumer preferences' argument is often used: as we become richer, we may want to buy relatively fewer manufactured goods and more services Third, differential productivity growth is seen as the key: productivity is growing much faster in manufacturing than services, so fewer workers are required to produce a given increase

in output, and there is a shift to services where more workers are needed (Rowthorn and Ramaswamy, 1997)

Likewise, debates continue to rage over the presentation of a rigid dichotomy between 'crucial', 'good', 'worthy' manufacturing jobs and 'unimportant', 'bad', 'worthless' service employment and the types of jobs created (see Rowley, 1999) Many policy makers, business people and commentators have become obsessed with one camp or the other, and this has all too often resulted in blinkered and mutually exclusive views

It is the case that 'manufacturing matters', but not to the exclusion of services, or vice versa At a simplistic level, manufacturing has to be 'serviced' There are low skilled, highly controlled service jobs, including many in fast food retailing and in the call centres of financial services At the same time, other service jobs are highly skilled and rewarding, both experientially and financially, and these can be in stark contrast to many

manufacturing tasks (for examples see, inter alia, Hamper, 1986;

Graham, 1995; Fitzgerald and Rowley, 1997) Examples of monotonous or disaffected employment include not just highly exploitative factory regimes, such as foreign-invested plants in China (Chan, 1996, 1998), but even exhalted Japanese companies, often depicted as exponents of empowerment (see Babson, 1995) These problems can be particularly acute in cases of overseas operations As Wong and Hendry show in their analysis of Japanese retailers in Hong Kong, issues of ownership, control and culture within international businesses directly influence the nature of local management, job prospects and commercial success

A mixture of 'push' and 'pull' factors have deindustrialized Hong Kong, whose manufacturers have transplanted the production of low value items, such as textiles, garments, electronics, plastics and watches, to mainland China (Ng and Poon, 1998) In some respects, there has been a reversion to an earlier entrepot role for Hong Kong What impact has this had on Hong Kong's human resources? Has the low skill and low value manufacturing that has migrated from Hong Kong to China been replaced with more upgraded, productive employment?

HUMAN RESOURCES Upgrading and skills are linked to human resources and employment, and the nature of work and management It is commonly argued that Hong Kong needs to break with its previous reliance on low cost, poorly skilled, tightly controlled work to higher skilled, more empowered and capital intensive production and employment As Carney and Davis point out, Hong Kong's predilection for lower skilled, highly utilized labour in predominantly small sized establishments reduces employee-generated innovations This is partly a result of the workers' restricted knowledge, which stems from the vertical shallowness of operations, unskilled, predetermined tasks and the sheer pace and intensity of work

A key area for human resources and upgrading concerns the supply of requisite labour through training and education The demand for management education in Hong Kong is assessed here

by Lee He notes how the arrival of cheaper international competition, Guangdong's development, and the rise of services at the expense of manufacturing have all altered the needs of Hong Kong's labour market The demand for technicians and professionals is increasing, but so is the human resource gap (partly because of emigration from Hong Kong before and after unification with China) The problem is especially acute in trade, retailing and services, with their new and growing requirements, and Lee demonstrates that Hong Kong will continue to suffer a shortfall in qualifications, despite efforts to expand tertiary education

Interestingly, Wheaton, in her survey of organizational commitment in Hong Kong, reveals that both Western and Chinese

employees seek to enhance their skills and so provide for their families Yet she confirms differences in the nature of organizational commitment, with Westerners viewing their firms as

a collection of people, systems and opportunities, while the Chinese see their commitment through personal relationships and networks Corporate strategies, clearly, need to take account of varying attitudes if their investment in employees is to be fully realized Wheaton does not focus on traditional Chinese family businesses, but on large or multinational enterprises, and it is such organizations that have the greater capabilities to invest in skills, empowerment, and technology

It is these cultural, institutional and historical differences that are addressed by Wong and Hendry in their evaluation of Japanese retailers operating in Hong Kong, and they link commercial success with human resource policies that gain the commitment of local managers Such ideas are seen as especially relevant and important

in an era when the 'service' component in many service sectors is seen as increasingly providing a distinctive competitive advantage They can involve the development of 'trust' (Fox, 1974), the move from 'control to commitment' (Walton, 1985) and even the manipulation of employees' 'hearts and minds' and so-called 'emotional labour' (see Hochschild, 1983)

CONCLUSION

The halcyon period of Hong Kong's phoenix-like rise retains its fascination for researchers, business people and policy makers alike Post-war growth can be seen as built on several pillars and adaptive mechanisms These range from the initial operating milieu

to the development of small organizations, which were highly flexible but limited by their production strategies, network structures, and employment practices

More recently, these underpinnings have been eroded and weakened, though the frantic search for low cost production has continued This short term response is a somewhat dangerous downward spiral to enter The international relocation of businesses is not new (see Vernon, 1966; Hirsch, 1967), and can often only be constrained or countered in particular circumstances (see Rowley, 1998b) As Hong Kong enters the new millennium as

part of China, the problematic nature of this rocky pathway will become not only more apparent, but also more difficult to navigate

NOTES

1 Figures based on purchasing power parities

2 From here on, the People's Republic is referred to as China

3 From now on the works of authors not fully referenced relate to their contributions in this volume

4 There is, of course, a heated debate about what constitutes 'small' for organizations, and how they are to be measured Variations in size can, moreover, be found across sectors, countries and over ti me

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Bacon, R and Eltis, W (1978) Britain's Economic Problem: Too Few Producers, 2nd edn London: Macmillan

Bacon, R and Eltis, W (1996) Britain's Economic Problem Revisited London: Macmillan Bae, J., Rowley, c., Kim, D.K and Lawler, J (1997) 'Korean Industrial Relations at the Crossroads: The Recent Troubles', Asia Pacific Business Review, Vol 3, No.3, pp 148-60

Bell, D (1974) The Coming of the Post-Industrial Society Penguin, Harmondsworth Berger, S and Lester, R.K (eds) (1997) Made by Hong Kong Hong Kong: Oxford University Press

Boltho, A (1996) 'The Assessment: International Competitiveness', Oxford Review of Economic Policy, Vol 12, No.3, pp 1-16

CAW (Committee for Asian Workers) (1995) Silk and Steel: Asian Women Workers Confront

Challenges of Industrial Restructuring Hong Kong: CAW

Chan, A (1996) 'Boot Camp at the Shoe Factory', Washington Post (Outlook Section), 3 Nov., pp 1-4

Chan, A (1998) 'Labour Relations in Foreign-Funded Ventures, Chinese Trade Unions and the Prospects for Collective Bargaining', in G O'Leary (ed.), Adjusting to Capitalism:

Chinese Workers and the State New York: M.E Sharpe, pp 122-49

Chan, Kit Wa, Fong, Yuek Hong, Fung, Kwok Kim, Hung, Sent Lin, Ng, Chun Hung, Pun, Ngai and Wong, Man Wan (1995) 'The Impact of Industrial Restructuring on Women Workers in Hong Kong', in Committee for Asian Workers, Silk and Steel: Asian Women

Workers Confront Challenges of Industrial Restructuring Hong Kong: CAW, pp 34-105

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Enright, M.J., Scott, E.E and Dodwell, D (1997) The Hong Kong Advantage Hong Kong: Oxford University Press

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Perspective, Vols I and II UK: Edward Elgar

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Fox, A (1974) Beyond Contract: Work, Trust, and Power Relations London: Faber Graham, L (1995) On the Line at Subaru-Isuzu: The Japanese Model and the American Worker Ithaca, NY: Cornell University Press

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Mole, D (ed.) (1996) Managing the New Hong Kong Economy Hong Kong: Oxford University Press

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pp ,4-61

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and Business Culture london: Casso

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Asia Pacific Business Review, Vol 4, No.4, pp 22-35

2

From Entrepot to Entrepot

via Merchant Manufacturing:

Adaptive Mechanisms, Organizational Capabilities and the Structure of the

Hong Kong Economy

MICK CARNEY and HOWARD DAVIES

Much has been written about the erstwhile high performing Asian economies (Riedel, 1988) whose (partially suspended) success has been variously attributed to 'getting the basics right' (World Bank, 1993), to government intervention (Deyo, 1987) or the lack of it (Balassa, 1981), and to the contribution of Confucian culture (Hofstede and Bond, 1988) This contribution makes no attempt to add to that literature, as it is not concerned to identify or rank the sources of growth What is put forward here is an analysis of the Hong Kong economy, viewed as a system of adaptation to the environment, within which organizations acquire certain distinctive capabilities That perspective suggests that a successful economy requires a discriminating system of adaptation within which different types of organization play different roles In that case they may also be expected to develop different types of capability If the nature of those capabilities is not easily changed then there will tend to be a form of 'path dependence' or 'lock-in' whereby certain development paths are foreclosed to certain types of organization and to those sectors of the economy that are dominated by those types of organization That foreclosure may not be for ever, but it must last for at least the period of time which is required to generate new types of capability

The analysis is developed in four parts The first sets out a conceptual framework for the analysis of adaptive mechanisms and organizational capabilities The second sets out the key features of the environment and the third divides the post-war history of the

Mick Carney, Concordia University in Montreal; Howard Davies, The Hong Kong Polytechnic University

Hong Kong economy into a number of distinct phases The adaptation mechanisms which arose are identified, and their implications for organizational capability are adduced Finally, the fourth part considers the implications of the pattern of capability for the future role and economic structure of the territory

THE THEORETICAL FRAMEWORK: ADAPTIVE MECHANISMS

AND ORGANIZATIONAL CAPABILITIES

The Hong Kong economy exhibits high performance and the starting point for the theoretical analysis is the assertion that such performance requires that there are mechanisms in place which support effective adaptation to changes in the environment As Hayek (1945) put it, 'the economic problem of society is mainly one of rapid adaptation in the particular circumstances of time and place' Williamson (1991) identifies two different types of adaptability The first he refers to as adaptation A (for autonomous), which operates through independent firms' reactions

to price changes which signal shifts in the supply and demand conditions in the environment This is the type of adaptive mechanism which corresponds to the neoclassical ideal and which Hayek referred to as the supreme achievement of the market mechanism That mechanism for adaptation will be most efficient when prices convey all of the necessary information concerning the actions which are to be taken in order to effect a necessary change

It will also be particularly effective when the form of economic and business organization provides high incentive-intensity, so that the rewards and punishments accruing to individuals are very directly linked to making or failing to make the changes which are signalled

to carry out because the actions of one firm (increasing output, for instance) require closely corresponding actions from the other, and self-interested bargaining over the distribution of returns may delay

or even prevent the adaptation from taking place If there are externalities arising in the production of a necessary adaptation (like benefits from research and development or labour force training) the autonomous responses of independent firms will lead

to sub-optimal spending Similarly, if the circumstances of time and place require investment in order to exploit significant economies

of scale or scope, adaptation of the autonomous type will be relatively inefficient because either coordination amongst separable activities is required (in the case of scope economies) or it would be inefficient for more than a few investments to be made (in the case

of scale economies)

In such situations, a different type of adaptation mechanism is required, referred to by Williamson as adaptation C (for coordinated) That involves the use of the managerial hierarchy rather than the market, and the coordination of different activities through formal organization Such a mechanism involves much lower powered incentives for the individuals involved because rewards are much less directly linked to making the appropriate changes, and bureaucratic costs are higher Nevertheless, there are many situations where hierarchy is a superior mechanism for adaptation, as witness Barnard's (1938) analysis of the role of the executive and Chandler's (1977, 1990) demonstration of the hierarchy's ability to secure the advantages of scale and scope, which led to the rise of the industrial corporation in the twentieth century In general, coordinated adaptation through hierarchies will be the more efficient solution in those situations where the entrepreneurial variant fails; that is, in the face of asset specificity, externalities, and economies of scope or scale

If an economy is to secure high performance, it requires an appropriate and discriminating mix of these different adaptation mechanisms, such that the system as a whole responds constructively to the constraints and opportunities imposed and offered by the external environment What should also be recognized, constituting the key conceptual development of this analysis, is that the different parts of the mix consist of organizations whose role in that mix leads them to develop different key capabilities or competences (Penrose, 1953; Barney, 1991) This is most obvious in the case of coordinated adaptation, where the mechanism is hierarchy and organizations are the focus

of attention However, even in the case of entrepreneurial

coordination, where the market is the key transactional nexus, firms exist (except in the limiting and empirically uninteresting case where all transactions take place between single individuals) Unless there is a truly pure market, operating through a Walrasian auctioneer, buyers and sellers have to be found, prices have to be set and discovered, gaps in time between sale, purchase and delivery taken care of, transactions recorded and transfers of property rights secured Organizations are needed in order to carry out these functions Large firms with deep hierarchies, providing coordinated adaptation, develop distinct capabilities in respect of circumventing the transactional difficulties which exist in the presence of economies of scale and scope (Chandler, 1990) Small firms providing entrepreneurial adaptation similarly develop their own distinct capabilities in 'operating the market' While networks

of small firms are sometimes regarded as providing a third and alternative form of governance (Carney, 1998), the fundamental building block of such networks remains the individual firm within which the key capabilities are located In this analysis, therefore, the dichotomy between 'entrepreneurial' and 'coordinated' adaptation is maintained, with network governance being treated

as a form of 'entrepreneurial' adaptation

If this hypothesis is supported, then it may be noted that the literature points to a number of key issues First, organizational capabilities cannot be rapidly changed or reproduced (Leonard-Barton, 1992), because they are the result of cumulative development processes, and are rarely well understood Secondly, they create a 'trajectory' along which organizations develop incrementally, until faced by some 'competence destroying' external development (Tushman and Anderson, 1986) In that case

a system of adaptation (especially an effective one where the existing capabilities have been well rewarded and therefore reinforced) will exhibit a degree of 'path dependence' which supports but constrains its future development

This contribution attempts to apply this conceptual framework

to the case of the Hong Kong economy It begins by examining the key characteristics of the city's environment and interprets the idiosyncratic structure of that economy as the installation of an efficient adaptive mechanism for that environment It then goes on

to consider the nature of the capabilities that evolved, the nature of the resulting path dependence and its implications for the future structure of the economy

KEY CHARACTERISTICS OF THE HONG KONG

ENVIRONMENT

The economic environment of Hong Kong exhibits a number of characteristics which may be seen to have influenced the adaptive mechanisms which have developed in the course of this century and

in particular since the end of the Second World War

The first of these is the small size of the domestic market The population in 1948 was around 1.8 million, generating a gross domestic product (GDP) of between HK$1.5 and HK$2 billion (Szczepanik, 1958) or around US$ 250 million at the 1948 exchange rate Even at that very low level of income savings were high by international standards and the domestic market for manufactures was very small indeed, most spending being directed towards food and shelter Such a limited domestic market renders self-sufficiency an impossibly inefficient solution to the problem of resource allocation The requirements for a high performance economic system in Hong Kong begin with the need for an export orientation

The second historically significant characteristic is the distance between Hong Kong and the world's major markets That distance has two significant dimensions The first is the physical distance from Hong Kong to Europe, the United States or Japan, which imposes both transport costs and transactions costs The second is the cultural and linguistic distance, which renders it extremely difficult for Hong Kong entrepreneurs accurately to read and interpret the needs and wants of final consumers in those markets The third key characteristic of the Hong Kong environment is that it is firmly located in Chinese culture, important aspects of which are reinforced and emphasized by the refugee history of the overwhelming majority of the population Foremost amongst these are the personalized nature of trust amongst unrelated individuals (Bond, 1986), which is a key hallmark of Chinese culture, accompanied by a lack of regard for formal organizational structures (Silin, 1976), mistrust of authority and the law (Hollows, 1995), and the low regard accorded to professional management (Redding, 1990)

The fourth characteristic is the sensitivity of the economy to external shocks arising from either economic or political developments over which the territory has no influence Changes in

the level of economic activity in other economies, particularly the

US, or in its pattern, are amplified in their impact on the demand for Hong Kong's output, and political changes may completely alter the pattern of market opportunities, resource availabilities and resource prices There have been at least four major external shocks

to the economic system since the Second World War, and innumerable minor ones The first major shock arose from the final stages of the civil war in China, culminating in the Liberation and the installation of a Communist government Those events precipitated an overwhelming influx of refugees, accompanied by significant amounts of capital and entrepreneurial skills (Wong, 1988) The second arose from the embargo on trade with China imposed by the United Nations after the Korean War broke out in

1951, which removed the demand for Hong Kong's entrepot services at a stroke The third arose from the opening of the Chinese economy, beginning at the end of the 1970s and in the early 1980s, which completely changed the pattern of labour and land prices facing Hong Kong entrepreneurs The fourth arises from the resumption of sovereignty by China in 1997, whose predicted consequences vary from the dire (Kraar, 1995) through the inconsequential to the highly encouraging

The fifth characteristic which needs to be taken into account is the policy of the state, in the form of both the local colonial government and that of the UK While these have not been as laissez faire as is often imagined (Schiffer, 1991; Yeung, 1991), public housing being provided for the majority of the population, for instance, and state manipulation of food prices supporting employers' need for low wages, they maintained a firm and credible commitment not to provide the colony's population with support, either directly through resource transfers from the colonial power

or indirectly through preferential access to the UK market Hong Kong's population was never in any doubt that it depended upon its own resources and efforts and significant entrepreneurial effort was not diverted to securing colonial favour

The impact of these environmental characteristics on the adaptive mechanisms adopted by the economy can be seen most clearly by tracing the colony's development since its inception, dividing that period into three main phases: the entrepot phase, which lasted until the outbreak of war in the Pacific, the export-orientated domestic manufacturing phase, which took place from

the end of the war until the early/mid 1980s, and the ization phase which began in 1981 with the opening of the Chinese economy and is currently returning Hong Kong to an enhanced version of its earlier role as an entrepot

deindustrial-PHASE I: FROM ANNEXATION TO WAR IN THE PACIFIC:

HONG KONG AS AN ENTREPOT

For the first century after the colony's establishment in 1842 Hong Kong was a flourishing entrepot, as its first Governor had predicted Imports came from China (38 per cent in 1939) and other countries outside Britain and its Dominions (48 per cent), while exports went largely to those other countries (66 per cent), China (15 per cent) and the British Dominions (14 per cent) Britain itself was not a major trading partner, which may account in part for the 'arm's length' approach adopted by the UK government The territory's

economy was dominated by the hangs, a group of large management

services companies owned and managed by mainly British interests,

who originally used Chinese or Eurasian compradors to manage

transactions between themselves, Chinese businessmen and the Chinese authorities The infrastructure which was needed to support the entrepot trade was dominated by the large British concerns, including Butterfield and Swire, and Jardine's in shipping, Whampoa and Wheelock in shipbuilding and ship repair (a sector accounting for 20 per cent of employment in 1940), the Hong Kong Electric Company and the Hongkong and Shanghai Bank, Hong Kong and Yaumatei Ferries, and the Star Ferry Company These non-Chinese organizations were all relatively large, having significant hierarchies staffed at senior level by expatriates, and they displayed significantly different organizational capabilities from the Chinese trading businesses with which they dealt (Crisswell, 1981) In this

stage of Hong Kong's development manufacturing was not significant There was some wool knitting and piece goods manufacture, and rattan furniture was made for local use Supply problems caused by the turmoil in China provided opportunities for the local manufacture of cigarettes, perfumes and confectionery, and small locally owned manufacturing began in footwear, hats, vacuum flasks, torches and batteries However, an economic commission in

1934 reported a total of only 419 factories, all of them small In

1938, the number of workers in registered factories was only

55,000 This grew significantly to 90,000 (Cameron, 1991) in the last years before the outbreak of war between Britain and Japan with

a gradual movement of mainland Chinese companies away from threatened areas of China and into the comparative stability of Hong Kong Nevertheless, before the outbreak of the Pacific War

Hong Kong's raison d'etre continued to lie in its entrepot function

This phase of Hong Kong's history came to an abrupt end with the Japanese invasion and occupation of 1941-45 which brought the suspension of all normal activities and institutions, significant physical destruction in Hong Kong and the flight or death of a large proportion of the population The colony which was returned to British rule had a population of only 600,000, some 80 per cent of whom were suffering from malnutrition Despite the harshness of the conditions inside the territory, the return of British administration was such an attraction that the population rose by 400,000 in the last four months of 1945, adding to the authorities' difficulties in re-establishing civil life and the economy

This desperate and chaotic situation was rendered worse by two sets of events in the early years of the 1950s The first was the outcome of the last stages of the civil war in China and the ensuing assumption of power by the Communists, which increased the flow

of refugees into the territory, quadrupling its population The second was the outbreak of the Korean War, leading to the US/UN embargo on trade with China which prevented any possible revival

of the entrepot function

By 1953 the territory faced an unprepossessing and apparently hopeless prospect with an impoverished population of 2.4 million largely uneducated refugees, no natural resources apart from a harbour, and a very limited manufacturing base Nevertheless, the system of adaptation which emerged was able to transform the city into one of the world's most prosperous locations, having a GDP per capita at purchasing power parity of US$ 21,670 in 1993, above that of the UK, Germany and Japan and exceeded only by the US and Switzerland

PHASE II: EXPORT-ORIENTATED MANUFACTURING, 1953-81

The environment in which the Hong Kong population found itself

in 1953 restricted the development options available and dictated

the form of the economy that emerged The extension of agriculture was not feasible because of the mountainous nature of the terrain, the lack of new cultivable land and the obsolete system

of land tenure and property rights in the New Territories, which prevented investment in agricultural infrastructure Mineral resources were negligible Entrepot activities between the mainland and the rest of the world were curtailed by the embargo Manufacturing for the domestic market was restricted by that market's size, leaving the production of manufactures for export, and the provision of services in support of that export activity, as the only opportunities for income generation and employment Within manufacturing, the choice of sector and the nature of the activities within those sectors was also constrained in a number of ways The pattern of the territory's resource endowments and comparative advantage dictated that its firms could only make sales overseas on the basis of cost-leadership in labour intensive sectors with low entry barriers (Riedel, 1974) The limited availability of capital prohibited investment in activities involving scale and scope, except where the influx of refugees had provided the colony with

an initial endowment of capacity (Wong, 1988), and the resulting industrial structure was very highly concentrated in a small number

of sectors Textiles and apparel accounted for more than 50 per cent of manufacturing employment in 1970, followed by plastic products (13 per cent) and electrical appliances and components (9 per cent) Hong Kong never developed those industries which hosted the development of the hierarchical modern industrial corporation in the US, the UK, Germany and Japan - automobiles, chemicals, heavy electricals Within the sectors which did develop, the physical and cultural distance from the territory's markets made

it too costly for Hong Kong manufacturing firms to identify the needs of final consuming households directly, and in any event the skilled labour and technological know-how which would have been needed to translate those needs into product designs and processes were not available Hong Kong firms were therefore forced to rely

on their foreign customers, working through the local import/export sector, for the provision of product designs which could be implemented by unskilled workers, and the construction and management of the marketing channels through which the resulting products reached the final purchaser

This focus on labour intensive sectors, small scale operations, and the organizational separation between production, product design

and marketing were clearly efficient adaptations to the nature of demand and the pattern of resource prices and availabilities The form of Hong Kong manufacturing was also significantly determined by the nature of Chinese culture and the vulnerability of the colony's markets to changes in the environment

With respect to Chinese culture, perhaps its economically most salient feature is the low level of trust which individuals exhibit towards those outside the extended family In the language of transaction cost economics (Williamson, 1985), that lack of trust engenders a high perceived threat of opportunistic behaviour in the context of contractual relationships between independent firms However, such opportunistic behaviour is only a real danger to the extent that firms have invested in assets whose value is specific to transactions with a particular party The threat may be attenuated

by investing only in general-purpose assets whose use can be switched if a buyer or supplier should prove unreliable (Carney, 1998) That same tendency is reinforced by the uncertainty stemming from Hong Kong firms' vulnerability to shifts in demand

in distant markets, with the result that their investments were limited as far as possible to generalized multi-purpose assets The manufacturing sector that developed in this phase of Hong Kong's development was therefore characterized by a number of features First, it grew very rapidly through the establishment of tens of thousands of new small firms rather than through the expansion of existing organizations (Riedel, 1974) Manufacturing employment rose from 100-200,000 in 1953 to a peak of around

1 million in 1981 Secondly, these small firms were overwhelmingly

Chinese family businesses (CFBs) The hongs did not become

significantly involved in the production operations of the manufacturing sector, and foreign direct investment played a very limited role

These CFBs displayed a very particular set of characteristics, identified in the work of Redding (1990) and Whitley (1992) They had very low levels of capitalization (Owen, 1971), largely in the form of machinery, and raised their initial financing from the personal savings of the family members Ownership and control lay with the family, authority being vested in one dominant executive Their activities were vertically very shallow 'single phase' operations using very general purpose assets and requiring little technical or managerial skill (Espy, 1965; Leary, 1965)

Competition took place on the basis of cost-leadership stemming from the availability of cheap labour, working at high intensity, and firms avoided the necessity, cost and transaction-specificity of investment or learning in product design and marketing by producing designs provided by customers and by imitating others

In terms of the 'value chain', such companies focused almost entirely upon managing the procurement of inputs at lowest cost, single phase production operations and order-taking As such, they were well described as 'merchant-manufacturers' (Riedel, 1974: 23) The physical proximity of such manufacturing firms to each other provided the benefits of an agglomerated production system (Scott, 1988), particularly in respect of rapid communication of information about market opportunities, the competence of suppliers and the creditworthiness of buyers

As one component in the system of adaptation, this manufacturing sector corresponded very closely to Hayek's market solution or Williamson's entrepreneurial adaptation A Hierarchies

in such small 'molecular' enterprises are so shallow as to be almost non-existent, a close approximation to the perfect market economy

in which all transactions are determined by price signals, as opposed to managerial fiat Incentive-intensity is very high and firms are highly responsive to small changes in costs, prices and the pattern of demand Family ownership and the ease of monitoring narrow scope operations encourages tight control over direct costs

in order to maximize the owners' residual return, and Hong Kong firms are models of parsimony The generalized nature of the assets

in use allows rapid changes in product variant, and product line If demand increases, a larger proportion of output can be devoted to more profitable lines When demand falls, full capacity operation can be maintained by switching to less profitable variants Market niches can be entered and exited rapidly, hence the finding that Hong Kong firms exhibit 'a high degree of strategic adaptability' (Redding and Whitley, 1990)

While the manufacturing sector itself provides a good example

of the way in which adaptation A can contribute to a high performance economy through small firms, this is not in itself a full explanation for Hong Kong's success in the period of industrializa-tion, because that sector alone could not manage all of the processes required to bring its output to market The vertical shallowness of the manufacturing sector dictated that inputs and

components be found and imported cheaply and efficiently, which required an effective infrastructure for communications, inbound trade and exporting

The system of infrastructure which supported the expansion of Hong Kong's manufacturing exports can be divided into two very different sectors The first consisted of the 'import/export' subs ector of the service industry, whose structure had close parallels with manufacturing and which made up another part of the entrepreneurial system of adaptation Establishment size was generally very small, with more than 15,000 autonomous CFBs responding to price signals, transmitting them and goods to and from the manufacturing sector, its customers and its suppliers Hierarchies were as shallow as in manufacturing, and capital intensity was low though higher th~m in manufacturing (Sung, 1991) The other sector was very different, being responsible for the highly capital intensive physical facilities which make up the banking, telecommunications and transport infrastructure In that sector economies of scale and scope are very significant, assets are highly specialized, often location specific, and efficient adaptation needs to take the coordinated form, requiring the development of much larger firms with hierarchical management structures As Chinese culture tends to be wary and inhibitive of such structures

this sector was dominated by the colonial hongs or British firms

with management cultures far removed from those of the local enterprises

In the period from 1953 until around 1980, the Hong Kong economy may be described as one in which high performance was achieved through a 'binary' adaptive system made up of two very distinct parts, containing two very different types of organization First, there were the thousands of small CFBs which made up most

of the manufacturing sector and part of the import/export sector Secondly there were a small number of 'peak organizations' made

up of large non-Chinese firms (and the Hong Kong government) which provided the infrastructure through their managerial hierarchies

As a system of adaptation to the changing circumstances of time and place, this was extremely successful Its flexibility and speed of response was legendary, particularly in respect of the ability to meet shifting patterns of demand in the low price, low specification segments of its major export markets Gross domestic product in

real terms rose rapidly at rates which swung wildly between 1 per cent and 17 per cent per annum in response to external conditions but averaged 10.1 per cent per annum in 1950-65 and 8.9 per cent

in 1965-83 Part of that growth arose from the absorption into the labour force of a population which grew from 2.1 million in 1952

to 5.3 million in 1983, but GNP per capita also rose by 5.5 per cent per annum in 1950-65 and 6.2 per cent in 1965-83 (Riedel, 1988) Despite this success, towards the end of the 1970s considerable unease developed in the colony over the continued viability of its manufacturing based economy and the ability of the system to adapt in a higher order way to new developments in the economy's environment In one sense that unease proved unfounded, but in others it remains In order to examine why that is the case, the next phase of Hong Kong's development needs to be examined in the light of our understanding of the nature of organizational capabilities

PHASE III: DEINDUSTRIALIZATION AND THE DEBATE OVER HONG KONG'S STRUCTURE, 1981 TO THE PRESENT

Towards the end of the 19705, concern was expressed in Hong Kong that the territory's ability to compete in export markets was being eroded by rising wages, the emergence of lower cost locations

in the region and the impact of protectionist policies in major markets The government commissioned a report on the possible diversification of the economy (Hong Kong Government, 1979) and began to examine ways in which Hong Kong could compete on

a basis other than cost-leadership in low cost segments The recommendations of that report were simply the first in a series of calls for Hong Kong's manufacturing industry to upgrade itself and the beginning of a reorientation of government's industrial policy away from 'positive non-intervention' towards 'minimum intervention with maximum support' (Yeh and Ng, 1994)

Such calls for Hong Kong manufacturing to move away from its historical emphasis on cost-leadership and to add more value through enhanced product design, the development of own brands and enhanced marketing capabilities, have become a routine part of the rhetoric emanating from senior government officials, academics, industry leaders and the press in Hong Kong (Davies,

1999) Billions of Hong Kong dollars have been invested in a new University of Science and Technology, with the express aim of promoting research and development A Science Park study has

been completed (Segal et at., 1992), an Industrial Technology Centre established, government grant schemes for research and development set up, and a privately sponsored 'vision and agenda' project carried out by a major firm of consultants (BPFHK, 1993) Despite this input of resources, the high profile interest and the continuous exhortation over a period of more than 15 years, there

is no convincing evidence that Hong Kong manufacturing firms in general have made any significant shift in their orientation, or any concerted attempt to make such a change The only figure available for Hong Kong's investment in research and development (Berger and Lester, 1997) suggests that in 1994 it was equal to 0.1 per cent

of GNp, compared with 2.88 per cent for Japan and 1.18 per cent for Singapore According to the OECD (1992), the index of Hong Kong's manufactured export prices did not rise at all between 1988 and 1994, and the ratio of value-added to gross output in manufacturing has also not changed between 1978 and 1991 (Whitla and Davies, 1995) Some firms have developed their own brands, but they are not widespread, and those that exist have little recognition in export markets A high proportion of companies carry out some aspects of product design in the territory, but a recent study (Ling, 1994) found that only 8.5 per cent of respondents could be described as 'design conscious' Most design work consists of making slight modifications to existing designs or designs provided by buyers, and companies' attitudes to design reflect a continuing priority placed on speed of development, stylistic changes and cost reduction rather than the enhancement of product performance (Davies, 1993) Government funded studies

of individual sectors consistently describe Hong Kong firms as strong in respect of styling and cosmetic changes but weak in respect of significant innovation and the skills required to implement world-class manufacturing (Kurt Salmon Associates, 1987; P-E Consulting Services, 1988)

The explanation for this 'failure' to upgrade the manufacturing sector is to be found in the opening of the Chinese economy to foreign direct investment, which took place at the end of the 1970s and the early 1980s.This gave Hong Kong firms access to supplies

of inexpensive labour and land at just the moment when they were

becoming unavailable in Hong Kong itself By transferring the more labour intensive parts of their activity to China, manufacturing firms were able to maintain their basic strategy of cost-leadership in low cost segments They did not come under commercial pressure

to develop new and different organizational capabilities, and they had no incentive to make investments in such change Entrepreneurial adaptation, through the autonomous responses of thousands of small firms to market signals, continued to be an effective mechanism for the manufacturing sector At the same time, the massive investments in infrastructure which were required

to support the increase in trade with China continued to be organized by the 'peak organizations' Instead of a change in the strategy of Hong Kong manufacturing, based on the development

of new capabilities, a change in the territory's economic structure took place at an unprecedented rate (Lee and Davies, 1995) This deindustrialization began in the early 1980s when the level

of manufacturing employment peaked at around 1 million workers and then began to fall dramatically, reaching around 400,000 in

1994 By that date the number of foreign-invested enterprises (FIEs) in China's Guangdong province exceeded 44,000, most of them from Hong Kong, and the number of workers in FIEs rose to

an estimated 6.5 million (State Commercial Bureau, 1993) The output of these enterprises was destined almost entirely for export through Hong Kong, so that new opportunities were created in those parts of the Hong Kong service sector which were 'manufacturing and trade-related' The territory returned to its historical role as an entrepot, with manufacturing accounting for less than 13 per cent of GDP and 20 per cent of employment This story of 'positive deindustrialization' illustrates both how well Hong Kong has been treated by events in China, and how well its system of adaptation has responded to the circumstances of time and place The opening of the Chinese economy has given Hong Kong manufacturing firms a 'breathing space' in which the existing adaptive mechanisms have proved sufficient to the task and no major new organizational capabilities were required However, the important question which remains is whether those firms would have been able to make such changes if China had remained closed and whether they will be able to make them in future when competition from other low cost manufacturing sectors asserts itself

It might be argued that as long as high performance can be achieved through the existing set of adaptation mechanisms and the existing set of capabilities there is no need to develop new approaches When the commercial need arises, bringing incentives for change, the business acumen of Hong Kong's entrepreneurs will

be brought to bear on the development of new capabilities

However, there are a number of reasons to suppose that such a shift may be impossible The most fundamental of these lies in the nature of the organizational capabilities which are associated with the adaptation A part of Hong Kong's adaptation 'mix' and the degree of change to those capabilities which would be required if manufacturing firms were to begin competing on the basis of innovation, non-trivial product enhancement and more extensive involvement in the marketing channel Hong Kong's manufacturing sector has more than forty years' experience of competing on the basis of cost and speed of response That is achieved by the close monitoring of vertically shallow, single phase assembly operations, carried out at a high intensity of effort by small numbers of relatively unskilled staff, using very general purpose equipment The 'dominant logic' centres on an emphasis

on 'quick money' made in expectation of a very short payback period The capabilities of these 'merchant manufacturers' are commercial rather than technological, centring on the quick response to opportunities to trade in products whose characteristics are specified by others and well codified

This set of capabilities militates against the upgrading of the manufacturing sector in a number of ways Firms' knowledge bases are highly restricted as the information which they need on inputs and markets in order to trade is largely reduced to prices, which are the most compressed, codified (and cheapest to absorb) form of information possible The ability to shift rapidly from one supplier

to another, and from one customer to another, is important for Hong Kong firms' current competitive stance, and it is supported

by the use of very general assets However, it prevents the development of the intense relationships with suppliers and customers that are required for effective innovation to take place The vertical shallowness of operations restricts the knowledge domain of the production workers and prevents them from identifying opportunities for innovation which arise in connection with the inputs to the process, the channelling of the output to final

customers, or the links between them 'Spanning' capabilities (Day, 1994) cannot therefore be developed Shallow hierarchies and a high intensity of effort allow for the containment of costs, but they also ensure that workers' time is wholly allocated to known tasks and cannot therefore lead to serendipitous learning A preponderance of unskilled workers, carrying out carefully programmed and predetermined tasks, is similarly inhibitive of innovation In each case, the organizational routines which embody the firms' capabilities and allow them to compete are inconsistent with learning and innovation

Research and development, enhanced market intelligence, the training of skilled workers and the development of brand names are all activities which require different and incompatible capabilities 'Patient money' and the willingness to accept long payback periods are required Idiosyncratic investments in learning about specific customers are needed, accompanied by firm-specific learning on the part of workers and the installation of more specialized equipment The existence of externalities and significant economies

of scale and scope are associated with all of the activities associated with upgrading, and they therefore require adaptation of the coordinated type through extended managerial hierarchies They cannot take place in a system of 'molecular' small firms unless, as

in the case of Silicon Valley (Florida and Kenney, 1990), those firms have very close relationships to large customers in close proximity

As such customers are not in evidence in the Hong Kong economy, they cannot compensate for the weaknesses of the small firm sector

CONCLUSION

Hong Kong has developed a system of adaptation which has proved very effective for more than 40 years, consisting of a manufacturing sector made up almost entirely of very small Chinese family businesses which respond quickly to price signals, set in an infrastructure provided and controlled by large hierarchies The manufacturing sector was driven into existence by the peculiar circumstances of the territory in the immediate post-war period, and those circumstances led the sector to develop a set of organizational capabilities which centred on cost leadership and rapid response The nature of those capabilities are such that Hong

Kong manufacturers are unlikely to be able to change their strategies towards technological upgrading and product differentiation They are therefore predicted to remain as 'merchant manufacturers'

The apparent inability of Hong Kong firms to change their strategic direction raises further questions about their role in the manufacturing sector in China As has been shown, the opening of the Chinese economy gave Hong Kong entrepreneurs a powerful price signal, and they responded by relocating part of their operations across the border In the first instance, that relocation has consisted largely of replicating the Hong Kong operation in China, often by physically shifting entire sets of plant and equipment The markets served remained the same and the contribution of the Hong Kong parties lay in their capabilities as described above - the efficient procurement of low cost inputs, management of single phase operations and order-taking

However, as the Chinese economy develops, the environment is changing in ways which may make the capabilities of the Hong Kong parties less relevant The Chinese market is increasingly large, though not yet sophisticated, and it is becoming an increasingly important source of revenue for manufacturers The difficulties of managing around a small local market and distant major customers, which did so much to form the capabilities of Hong Kong firms, are

no longer so important As a result, Hong Kong manufacturing firms may be badly adapted to the emerging needs of the Chinese economy

Firm evidence in support of that conjecture is not currently available but there are a number of indicators which suggest that it may be valid The average size of a Hong Kong firm's manufacturing operation in China appears to be significantly larger than anything which the Hong Kong firms managed within the territory Such firms require considerably more extensive hierarchies than the typical Hong Kong operation, and at least one Hong Kong government report has pointed to lack of mass production management skills which are required for the effective operation of factories in the Pearl River Delta If economies of scale and scope can feasibly be exploited in China, Hong Kong's established adaptive mechanisms, and the firms which make up that mechanism, may be inadequate to the task In that case, we may observe the gradual withdrawal of Hong Kong interests from active

managerial involvement in Chinese manufacturing Hong Kong

will have completed the full circle from an entrepot economy in

1945, to a manufacturing centre in the 1970s, to an entrepot in

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