The real issue in Hong Kong protests

In the next three years, Hong Kong must choose its economic future. And that choice will make or break Hong Kong as we know it today.

For a week, international media has provided dramatic coverage from Hong Kong. According to the narrative in the West, Hong Kong is struggling for democracy. The real story is more complex and nuanced.

Anti-Occupy Central protesters stand behind a police cordon on Nathan Road at Hong Kong's Mongkok shopping district October 3, 2014.
Bobby Yip | Reuters
Anti-Occupy Central protesters stand behind a police cordon on Nathan Road at Hong Kong's Mongkok shopping district October 3, 2014.

Rising economic uncertainty

Since 2008, cheap mortgages, constrained supply, GDP growth and demand from overseas have pushed up property prices in Hong Kong by 135 percent (300 percent from their trough in 2003), which far exceed the increase in rents or wages. Today, Hong Kong is the most expensive city after London. Some observers expect price declines in excess of 30 percent over the next few years.

In 2013, Hong Kong's growth recovered to 2.9 percent. By May, the International Monetary Fund (IMF) still anticipated external demand to lift growth to 3.7 percent in 2014. But Hong Kong's GDP was already contracting, based on the 2nd quarter data.

Read MoreEconomics plays a large role in Hong Kong protests

As the protest movement began to escalate its activities in the spring, Chinese visitors spent less or simply stayed away. When Hong Kong's retail sales plunged 9.8 percent in April, panic ensued in the markets and retailers came out to oppose efforts to limit visitor numbers.

Through the summer, Hong Kong was swept by Occupy Central marches and deepening political divisions.

Usually, Chinese tourists visit Hong Kong en masse following the mainland's National Day on Oct. 1. But as civil unrest escalated during the past week, Hong Kong's economy has taken a heavy blow. As a result, the downtrend in retail sales is likely to extend beyond its six-month slide.

As a small and highly open economy, Hong Kong is also heavily influenced by global developments, particularly the Fed tapering and China's economic transition. Since the Fed is expected to hike rates by mid-2015, Hong Kong stands to benefit from tapering, if the latter is associated with a recovery in U.S. demand. This is no longer a sure thing, however.

Read MoreWill Hong Kong spark an Asian spring?

Weakened consumption and slower home-price appreciation continue to penalize U.S. growth, along with the aging population. The recent U.S. jobs report tells the story: solid job growth, but weak wage growth.

Three decades of growth — on the back of China

Recently, Chris Patten, the last British governor of Hong Kong, accused China of reneging on its commitments. The political irony is overwhelming. When Hong Kong was under British administration from 1841 to 1997, the UK did not promote democracy. That began conveniently after the handover.

In early 2013, pro-democracy forces participated in protest marches with many demonstrators carrying the former British colonial flag. At the same time, misguided colonialist nostalgia has been accompanied by ugly discrimination of the mainland Chinese, even virulent bullying.

The economic paradox is more poignant. From Chinese reforms to the handover, Hong Kong's living standards quadrupled. In 1980, they were 40 percent below those in the UK; in 1997, 15 percent higher. This achievement was not automatic.

Amid the handover, the Asian financial crisis caused property prices to plunge. Next year, China's then-premier Zhu Rongji promised the central government would protect Hong Kong "at all costs." Speculative attacks were rebuffed.

Until the 2008-2009 global financial crisis, Hong Kong's growth record remained fairly strong, thanks to stable post-handover transition, China's export-led growth and Hong Kong's role as a financial intermediary for Chinese companies and investors.

By 2013, Hong Kong's per capita income was one of the highest in the world — over $52,700. That's about the same as in the U.S.

Hong Kong-China integration

Economic integration is measured by flows of trade, investment, and people. Today, China is Hong Kong's largest export partner (58 percent) and its largest import partner (45 percent). Over 75 percent of foreign direct investment (FDI) can be traced directly to China or to Chinese companies incorporated abroad. In 2013, some 75 percent of Hong Kong's foreign visitors were from China.

Without China, Hong Kong would be left only half of its trade, one-fourth of its foreign investment and visitors.

Three decades ago, China needed Hong Kong more than Hong Kong needs China. Today, the roles have reversed. In the past, Hong Kong served as China's primary financial channel. That role remains vital, but today China has alternatives and in the future Shanghai will be China's financial engine.

The trend line is exemplified by foreign investment flows. The latter were reset around 2012, when FDI flows to Hong Kong fell by more than 20 percent, whereas inflows to Shanghai increased by over 20 percent.

Hong Kong is the main offshore RMB center. But it will thrive only as long as it is attractive to the mainland companies' fund-raising activities.

With its broad capabilities, Hong Kong remains a leading global financial hub, but Shanghai is catching up. And as Shanghai's free-trade zone took off a year ago and the renminbi will become convertible in the coming years that will reinforce the megacity's future as a global center for trade and finance.

What next

Hong Kong does have an economic future, but that requires political reconciliation. With further integration into the neighboring province of Guangdong, it could alleviate the challenges associated with Hong Kong's maturing economy, aging population and entrepreneurial innovation.

What's most worrisome is the huge discrepancy between Hong Kong's economic gains and its eroding social fabric. Indeed, the right parallel for Hong Kong's protests is not Ukraine in which the GDP per capita, adjusted to inflation, is just 40 percent of that in Russia. In fact, the Hong Kong situation is precisely the reverse of that in Ukraine. In China, GDP per capita is barely 15 percent of that in Hong Kong.

The real precedent for the Hong Kong protests is the "Occupy Wall Street" movement in the U.S., which reflects income polarization and diminishing opportunities that place an extraordinary burden on the youth.

Hong Kong's income inequality, as measured by the Gini Index, is worse than in Zimbabwe – despite all the wealth that the city has gained from China's economic reforms and opening-up policies.

Nevertheless, this polarization is not the result of economic integration with China, but of inadequate social cohesion in Hong Kong.

What Hong Kong needs is responsible political development, adequate social policies and further economic integration. In the next three years, Hong Kong must choose between steady integration and slow decay. That's the choice that will make or break Hong Kong's economic future.

Commentary by Dan Steinbock, a research director of International Business at India China and America Institute (USA), visiting fellow at Shanghai Institutes for International Studies (China) and in the EU-Center (Singapore). See also