China wants to build an innovation capital by fiat. Can it?

South China Morning Post

Inclusion of R&D spending in GDP calculations means mainland city may soon overtake its illustrious neighbour

Once a small fishing village on the outskirts of Hong Kong and not so long ago a haven for manufacturing sweatshops, Shenzhen, in southern China’s Guangdong province, might very soon overtake its illustrious neighbour in economic terms.

In the first three quarters of 2017, the boomtown’s economic output rose 8.8 per cent year on year to 1.54 trillion yuan (US$232.66 billion). While the figure fell short of Hong Kong’s HK$1.94 trillion (US$248.27 billion) for the period – up about 7 per cent in nominal terms from the first nine months of 2016 – the gap between the pair is narrowing.

What’s more, an official from the Shenzhen statistics bureau, who declined to be named, told the South China Morning Post that the city’s economy was set to receive a significant boost as a result of a revision to accounting methods.

“In the fourth quarter, we will follow the provincial statistics department’s lead in using a new method of calculating gross domestic product to revise up Shenzhen’s economic figures for the year,” the person said.

On Tuesday, the Guangdong statistics bureau released revised economic figures for 2016 for its major cities and the province as a whole. The changes followed a ruling from Beijing that when calculating GDP, officials should regard spending on research and development as a fixed investment rather than an operating expense.

As a result, Shenzhen, which is home to numerous technology firms, including giants Tencent, Huawei and DJI, all of which are known for their massive spending on R&D, saw its 2016 GDP figure rise by about 60 billion yuan to 2.01 trillion yuan. Such was the increase that it overtook Guangzhou as the largest city economy in the province.

Assuming it maintains the growth rate it achieved over the first three quarters, Shenzhen’s nominal GDP for the whole of 2017 would be 2.19 trillion yuan, or US$330.86 billion.

Hong Kong’s GDP for 2016 was HK$2.49 trillion. Assuming it, too, maintains its nine-month growth rate of about 7 per cent, the total for 2017, again in nominal terms, would be HK$2.66 trillion, or US$340.41 billion, or less than US$10 billion more than Shenzhen’s.

“Based on the current situation, it’s only a matter of time – maybe next year or the year after – before Shenzhen’s economy overtakes Hong Kong’s,” Simon Zhao, founding director of the International Centre for China Development Studies at Hong Kong University, said.

Despite the gains in the headline figures, it could be some time before Shenzhen overtakes Hong Kong in terms of GDP per capita, however. In 2016, the figure for Hong Kong was HK$339,000, or nearly twice that of Shenzhen.

One of the main reasons for Shenzhen’s stellar economic growth is that most companies based there are either privately owned or foreign-funded, according to Qu Jian, deputy director of the think tank, China Development Institute, which is also located in the city.

Such firms tend to be more innovative and willing to take risks, which has helped to drive technological innovation and industrial restructuring in the city faster than anywhere else in China, he said.

The combined value of Shenzhen’s six strategic industries – biotechnology, information technology, new energy, telecommunications, cultural and creative, and new materials – rose 10.5 per cent in 2016 to 780 billion yuan, or close to 40 per cent of gross domestic product.

Last year, Shenzhen invested more than 80 billion yuan in research and development, or about 4 per cent of its GDP, the highest proportion of any Chinese city.

Since 2013, Shenzhen has allocated more than 4 per cent of its annual GDP to R&D, putting it on a par with South Korea and Israel.

Despite the perceived rivalry between the two cities, ties between Hong Kong and Shenzhen are strengthening.

Tencent is now regarded as the most important stock on the Hong Kong market, while DJI, the world’s largest drone maker, was founded by Wang Tao, who studied at a Hong Kong university.

“Integration is the best way for both Shenzhen and Hong Kong to grow their tech and finance industries,” Zhao said.

“But they also face their own individual risks. Shenzhen, for instance, must be alert to issues of overcapacity in the manufacturing of drones, robots, smartphones and other electronic products, while Hong Kong is prone to changes in foreign markets, like US’ interest rate hikes and capital outflows.” he said.

Zhao said that due to fears of economic bubbles within China there were likely to be huge capital flows moving southwards from the mainland into Hong Kong next year.