Cheap Chinese Goods Are Becoming a Costly Problem. Exhibit A: Hong Kong.

Hong Kong residents are flocking to China amid falling prices there. PHOTO: GILLES SABRIE/BLOOMBERG NEWS
Hong Kong residents are flocking to China amid falling prices there. PHOTO: GILLES SABRIE/BLOOMBERG NEWS

Summary

Shoppers are hopping across the border, where prices have dropped. Neighboring Asian countries could also be hit if Chinese companies dump their goods there among weak domestic demand.

Prices are falling in mainland China. That’s a boon for people living in Hong Kong, but a big problem for the city’s businesses.

Consumer prices in China fell 0.8% in January compared with a year earlier, the country’s biggest deflation reading in more than a decade. That is a sign of the tepid state of the world’s second-largest economy, where a sputtering recovery has knocked confidence and encouraged Beijing to censor some economic research.

Hong Kong residents are increasingly hopping across the border to the city of Shenzhen, where they load up on frozen food and cheap furniture at big-box stores like Costco and Sam’s Club. Hong Kong business owners, unable to compete with their Chinese counterparts on price, are feeling the squeeze.

“Walking on the streets these days, you’ll feel that Hong Kong retailers are in big trouble," said the city’s former financial secretary, John Tsang, in a recent social-media post.

Graphic: WSJ
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Graphic: WSJ

The pain being felt by businesses in Hong Kong offers a partial answer to a question that has been debated by economists for much of the past year: How will deflation in China impact the rest of the world?

Chinese export prices have dropped steadily since late 2022 and were 8.4% lower in December than they were a year earlier, according to customs data. Economists think that’s probably a good thing for Europe and the U.S., where central banks have been forced to embark on an aggressive series of interest-rate increases to keep rising prices in check. But the impact on smaller countries could be more troublesome.

China is the biggest trading partner for multiple countries across the world, and is particularly influential for countries in Asia. The risk for these countries is that Chinese companies dump their goods overseas in response to weak demand at home. They can also undercut manufacturers in countries like Vietnam and Malaysia, which have slowly been muscling in on China’s status as the world’s factory.

“This Hong Kong story is applicable to countries that are near the neighborhood of China because the supply chain is much smaller," said William Lee, chief economist at the Milken Institute, an economic think tank. The shorter supply chain for China’s trade with its neighbors means changes in price pass through more directly, rather than being swallowed up by the various companies that get involved in shipping goods over longer distances.

China’s neighbors in East Asia don’t have the option to impose protectionist policies against it, analysts at Citigroup wrote in a January note. China is simply too big a force in global trade for them to risk its ire.

Graphic: WSJ
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Graphic: WSJ

But if it is hard for China’s neighbors to push back against falling prices, it is even tougher for Hong Kong—which is run by a pro-Beijing government that wants closer integration with the superpower next door.

Hong Kong residents are partly benefiting from the strength of the U.S. dollar. The Hong Kong dollar is pegged to the U.S. dollar, and the city’s de facto central bank has copied the Federal Reserve’s historic series of interest-rate increases over the past two years. China’s central bank has gone in the opposite direction, cutting rates in an attempt to boost the moribund economy.

Since the end of 2021, the Chinese yuan has lost more than 11% of its value against the Hong Kong dollar.

Counting the cost

Hong Kong’s economy grew 3.2% last year, clawing back some lost ground after a 3.7% contraction in 2022. But the numbers mask a host of difficult problems, including an exit of foreign businesses, a prolonged slump in the real-estate sector and the lowest fertility rate in the world.

The apparent embrace of what mainland China had to offer would have appeared unthinkable five years ago, when the city was swept up in massive antigovernment protests. Back then, shoppers and diners looked up color-coded maps to help them identify businesses that shared their political stance to patronize—and avoided those perceived as having links to mainland China.

But years spentcooped up in Hong Kongduring the pandemic and penny-pinching by anxious residents has helped boost Shenzhen’s appeal.

“We’re seeing a readjustment of our way of life that suggests economic interdependency between Hong Kong and Shenzhen," said Edmund Cheng, a political sociology professor at the City University of Hong Kong.

Last year, Hong Kong residents made more than 50 million trips up north following the lifting of all pandemic-related travel restrictions in February, according to Hong Kong Immigration Department data. That’s still below prepandemic levels, but their spending power helped boost retail sales in Shenzhen, which rose by 7.8% in 2023, recording one of the biggest jumps at any mainland city last year.

In a survey by a business lobby last year, just 37% of Hong Kong businesses said they expected revenue to grow in 2024. Less than a third thought they were on track to beat prepandemic levels.

Korsy Lee, 39, is one of many Hong Kong residents who make a regular pilgrimage to Shenzhen—and earns a profit from it. He began shuttling goods back from Shenzhen last August as a side hustle, and now goes there four times a week, loading up his Toyota minivan with frozen hamburgers, fish maw soup, Panasonic dishwashing machines and even toilet-paper rolls. He takes orders from customers and charges a flat fee.

“Eighty percent of my customers are housewives who want to make every penny count," he said.

Write to Clarence Leong at clarence.leong@wsj.com

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