Hong Kong’s “Special Trading Status” with the United States: What is at Stake?

Trade policy and the workings of the multilateral trading system under the World Trade Organization (WTO) can be an arcane business. Specialists will have picked up that something is missing in recent news reports and analysis about the intention of the United States to withdraw Hong Kong’s so-called “special trading status” as a measure in response to China's decision to introduce a national security law in the special administrative region (SAR).

The fact is that Hong Kong does not have, and never has had, an overarching preferential trade agreement with the US. As regards trade in goods, Hong Kong and the US trade with each other on the basis of “most-favored nation” (MFN) tariffs” – or, to use the recent Brexit jargon, “WTO terms”. 

This means that US imports from Hong Kong have exactly the same tariff treatment as imports from the European Union, India, Brazil and the whole host of other countries with which the US does not have a preferential free trade agreement. In return, in line with its longstanding policy, Hong Kong imposes no tariffs on its imports from the US or anywhere else.

The only area in which Hong Kong has had preferential treatment is in relation to the US’s export controls on so-called sensitive technology. Up to now, Hong Kong has been able to satisfy the US that it has adequate controls in place to prevent leakage of such technology and so it has had access to some of these products. But this is a matter which has always been entirely within the gift of the US and it is not covered by WTO rules.

Hong Kong’s exports to the US are in the region of US$4 billion, which is 3 percent of its total exports, according to Observatory of Economic Complexity figures for 2017. The main items are machinery, precious metals, textiles and clothing, and toys.

Over the course of the last two years the US has imposed unilateral additional tariffs of up to 25 percent on almost all imports from China. These higher tariffs exceed the US’s ceilings under its WTO obligations. The US justifies them under the WTO’s security exception (Article XXI of the General Agreement on Tariffs and Trade, or GATT) but China is challenging this. The question now is whether the US will extend these additional tariffs to Hong Kong, which is recognized in the WTO as a separate customs territory from China.

Trade in services is more complicated. The barriers are not at the border but in a labyrinth of domestic regulations. Moreover, market access commitments at the WTO usually lag well behind the actual situation on the ground. The US does have a general obligation to treat Hong Kong services and service suppliers no less favorably than it treats those of other economies. But beneath this level of generality, regulations can be tweaked to obtain the desired effect.

There are other areas beyond the realm of the WTO in which the US could also act against Hong Kong. For example, Hong Kong has an agreement with the US on the Container Security Initiative, a Washington-led maritime security program launched in the wake of the September 2001 terrorist attacks. Hong Kong participates in other initiatives against terrorism and money laundering. The US would need to consider the point at which punishing Hong Kong might become counter-productive.

If the US does impose additional tariffs beyond its WTO ceilings on Hong Kong goods, or discriminates against Hong Kong in trade in services, the Hong Kong government will have a choice to make – whether to challenge such measures at the WTO. Hong Kong has exactly the same rights in the WTO as any other member, including a right to complain to its Dispute Settlement Body and to ask for a panel to be established to examine its complaints.

If on the other hand Hong Kong declined to challenge any form of WTO-inconsistent discriminatory US behavior, it would also run a serious risk. It might send a signal to trading partners that it is not going to defend its rights in the WTO. Others might then be tempted, in time, to follow the US lead.

While this seems unlikely in the case of trading partners who are still strong supporters of “one country, two systems” (such as the UK, the EU, Australia, Canada, Japan and others), there could be other countries with fewer scruples who might not be so restrained. There might then be a slow-motion domino effect. In the longer term, Hong Kong’s position as a separate customs territory and WTO member could be at stake.

The surreal nature of the choice which Hong Kong might well face, or the fate that might await it, is amply illustrated by a submission which the US itself made to the WTO as recently as February 2020. The US proposed that the WTO should issue a declaration on “The Importance of Market-Oriented Conditions to the World Trading System”.  

The US listed a series of criteria as indicating the existence of a market-oriented economy, tests which, as the US well knows, the Hong Kong economy would meet far easier than most WTO members. Yet only three months later the US is threatening trade discrimination against that same economy.  

There is no easy solution but, in my view, in the event of any US discrimination, Hong Kong has to stand on its principles and challenge the action in the WTO.  Otherwise it will not be taken seriously as an international trading entity.