THE BLOG
10/14/2014 01:30 pm ET Updated Dec 14, 2014

Chasing Chinese Dream(s)

The protests in Hong Kong are entering their third week. As a result, the risk of more direct confrontation and resulting uncertainty is increasing. Commentators warn of possible physical intervention, evoking China's violent crackdown on the 1989 student protests on Tiananmen Square. However, the situation is not a zero-sum game but one of interdependence. Hong Kong and Beijing can only solve the current gridlock together. But Beijing's wider ambitions for a 'great revival of the Chinese nation' may stand in the way.

For many democrats, the protests in Hong Kong mark a turning point. If the people of Hong Kong were to accept the restricted version of universal suffrage, they would effectively give in to Beijing dictating the terms of future constitutional change. The protestors have made clear that this is not an option. They are willing to undermine Hong Kong's stability and reputation to 'save' the city, even though the costs of political stalemate are high. Time favors the protesters, not Beijing. The longer the demonstrations go on, the more citizens learn about the protests and the more foreign governments are likely to signal their support. Pressure on Beijing is therefore mounting to resolve the situation, both domestically and internationally.

Troubled by the unwanted limelight, Beijing has adopted a 'wait them out' response. But this has done little so far to discourage the demonstrators. If anything, their numbers have increased over the weeks. But Beijing cannot simply stand by and do nothing about a considerable number of people, especially the young, who are willing to disobey authority, take to the streets and claim greater political rights. This is where the true clout of civil disobedience lies: It is the power of perception that may escalate pressure to the tipping point. If China were to use force, it would not only damage its international reputation. It would also undermine the domestic credibility of its 'one country, two systems' strategy. By closing off the path for greater popular say in the political process, Beijing risks alienating considerable parts of Hong Kong's population.

The fertile soil that Beijing's response provides for long-term political tensions are one side of the story. Economic risks are another. Hong Kong has long been a global hub for cross-border trade and investment flows. It also serves as the main bridge connecting China to the world. To be fair, this significance has waned, as the Chinese government has started to open its borders and promote Shanghai as its financial centre of choice. However, the city still has a long way to go before it will be on par with its offshore counterpart. The role of Hong Kong as a global financial center and testing ground for financial reform therefore remains crucial for Beijing.

Ongoing gridlock or a poor response from Beijing in handling the situation would also send worrying signals to foreign firms with investments in the mainland. It would raise serious questions about the government's ability to safeguard stability, as China moves towards middle-income status and with it the demands of its population. Despite recent efforts to shift the country towards consumer-led growth, China is still heavily dependent on foreign investment for the time being. As a result, any flight of foreign capital would likely affect economic growth, upon which the government's legitimacy rests. The knock-on effect of a crisis in Hong Kong would therefore have serious implications for the systemic stability that the government wants.

At the same time, Hong Kong needs the mainland, and increasingly so. China's offshore financial market in Hong Kong has grown considerably in size in recent years. Since 2010, the volume of yuan-denominated deposits in Hong Kong has increased thirteen-fold to over USD 132 billion. There has also been a large increase in the volume of yuan-denominated 'dim sum' bonds issued in Hong Kong. Carry trade, a currency strategy to capture spread between interest rates, has partly financed the immense property booms in the mainland. Hong Kong banks are at the heart of such financing. They have been the go-to institutions for China's carry trade. Their net lending to the mainland has increased from 18 per cent of Hong Kong GDP in 2007 to 148 per cent this year. This makes clear that the growth of Hong Kong's financial sector, which makes up the largest chunk of the city's GDP, is heavily reliant on the mainland.

This economic interdependence and the aforementioned reputational risks show that a solution would not be winner-take-all. Hong Kong and mainland China are both in the same boat. The two parties must realise that they need to work with each other, not against each other, if a more serious crisis is to be averted. However, the real problem in solving the political impasse may lie deeper. In 2012, President Xi Jinping declared that the 'greatest Chinese dream' was the 'great revival of the Chinese nation.' As a result, the Chinese government is not prepared to grant Hong Kong its own political identity. Beijing views itself as the rightful sovereign over Hong Kong's territory. It justifies this role through the Basic Law that provides the legal foundation for Hong Kong's status as a sub-national region with autonomous privileges, not a sovereign territory. However, the protestors in Hong Kong have a different dream for their hometown. Effective governance in Hong Kong will require giving its citizens more direct choice in who runs their city. This is hard to achieve without a greater mandate for its chief executives rather than a mere approval stamp from Beijing. In the end, it may thus be the idea of a grand and unified Chinese nation that stands in the way of turning the 'one country, two systems' strategy into a plausible solution for Hong Kong. Without addressing the lack of faith in the political leadership and listening to the Hong Kong version of the 'Chinese dream', the city may soon become a hotbed for more serious political tensions.