At midnight on June 30, 155 years of British rule in Hong Kong cease. The handover to China raises complex questions for the colony's institutions, economy and citizens, with Hong Kong's thriving universities firmly at the core of its people's hopes and fears. The É«ºÐÖ±²¥S looks at the issues involved

Gerald Segal argues that the problems Hong Kong faces after July 1 can only be solved if its people are given the freedom to tackle them.

The handover of Hong Kong to China on July 1 is both the last major phase in British decolonisation and a symbol of Britain's more modern relationship with the booming Pacific Asia region. The United Kingdom can take enormous pride in the fact that never before (apart from Australia's independence in 1901) has colonial rule ended with the colonised people enjoying so much wealth and such a vibrant civil society. For this reason alone, there should be much optimism about Hong Kong, at least in the short term.

But it is also true that never before has a colony, rather than being granted its freedom, been handed to a country that is poorer and less free. This combination of unique circumstances has made Hong Kong a litmus test for the outside world anxious to judge whether China will protect the freedoms of Hong Kong and transform itself into a more cooperative member of international society.

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The unique combination of factors also makes it difficult to judge what lies ahead for the six million industrious people of Hong Kong. Far too many of the answers are sought in the arcane debates about minute differences in Hong Kong's public ordinances or the elliptical statements of Chinese officials. Although there is a real and worrying erosion of civil liberties in Hong Kong, the main focus of attention should be the longer-term challenges. China and the outside world can affect the outcome, but an important determinant of success lies in the will and the wits of the people of Hong Kong.

By far the most important challenge for Hong Kong is how to reshape its economy. Like other developed East Asian economies, Hong Kong has to learn to live with a "hollowed out" industrial base and in an increasingly competitive world of service economies. In recent years it earned easy profits by using cheap labour in China and adding the design, marketing and other service sector talents of Hong Kong. But as the cost of doing business in Hong Kong rises (port charges, for example) and Chinese labour becomes more expensive than in Vietnam, Indonesia or India, the city faces a massive economic challenge. Hong Kong relies on the American export market, but under the North American Free Trade Agreement, Mexican labour can undercut Hong Kong prices. Hong Kong can no longer compete on price, and for business it is proving hard to find competitive advantages in technology design or high-quality personnel.

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The coterie of successful Hong Kong business leaders that surrounds the chief executive-designate, Tung Chee-hwa, is quick to note the economic challenge but often seems short of new ideas about how to enhance competitiveness. It is far from clear that a Hong Kong ruled by business tycoons will be better at meeting these challenges than one ruled by a distant London and a first-class local professional civil service with a laissez-faire approach.

The competition among the business interests in Tung's new team largely explains the lack of economic vision. They talk of their enduring advantage in "distribution process technology'' but there is little evidence to support the jargon. Some talk of "a new industrial policy'' with echoes of nearby China. Others wax lyrical about "a new high-tech Hong Kong'' that suggests a Singapore model. Yet others note the serious need to improve the living environment - an implicit call to clean up the air and water and restrict the economics-in-command model. All agree that housing policy needs to be improved to reduce rents and attract more talented workers. But there are some in the new team who will lose a fortune if real reform is undertaken and land prices fall. Those in the banking sector will also lose out if there are changes that introduce foreign competition that breaks up current cosy arrangements. These are all tough choices that will pose the real test for the new team.

A related challenge is education reform. A cutting-edge service economy, let alone a high-tech Hong Kong, will need to raise its higher education standards to developed world standards. But a brain drain in recent years and the freely articulated fear of Hong Kong academics about a more restrictive regime under Chinese rule ensures Hong Kong is less ready than the likes of Taiwan, South Korea or even Singapore for post-industrial competition. The challenge for Hong Kong is not so much the reform of textbooks, but rather the creation of a real spirit of freethinking necessary to set up a "Silicon Valley'' in Kowloon. It is worrying that Tung's team speaks of more investment in primary education to ensure basic skills and Asian values when the real weakness is in meeting the challenge of creating an innovative higher education system.

The current obsession with short-term challenges in Hong Kong also obscures the far more difficult questions of political reform. The grudge match between the British government and the incoming team over the legality of the Provisional Legislature is insignificant compared with how forces in the new legislature, to be elected by July 1998, will form new political parties and struggle with the chief executive and his executive council for real power.

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According to the Basic Law half the legislature will be fully elected in 2007. If two-thirds of the new legislature agree, and the chief executive assents, Hong Kong can have a fully elected legislature on the basis of universal suffrage. How would such a legislature relate to an unelected chief executive? Will Hong Kong also have elections for a "chief minister'' with a real cabinet and a legislative majority?

These far-reaching democratic reforms are there for the taking, but the people of Hong Kong have to agree on their design and then vote and fight for them. With determination to defend their rights under the Basic Law, the people of Hong Kong can make the debates about "functional constituencies'' seem like the detritus of colonialism. If only the people of Hong Kong had more actively demanded political rights earlier in colonial rule, arguments about hobbled forms of democracy would have been long past. But Hong Kong did not demand more self-determination for the same reason that it is unlikely to take charge of its own political system - fear of China. Hong Kong has always known that because China controls its food and fuel supplies, the territory could never be free.

This raw reality helps explain yet another challenge for Hong Kong - how to deal with what some of Tung's advisers call "Beijing's shoe-shiners''. Tung is often pilloried for being China's poodle, but as anyone who meets him knows, he is by nature a careful conservative in a Confucian mould. Tung needs no instructions from Beijing to take a tough line on dissidents or street protests - he naturally stresses the importance of obligations more than rights.

But the new team does acknowledge the problem with some of its number - the shoe-shiners - who are too quick to second guess Beijing's beliefs and not think hard enough about what is good for Hong Kong. Such pre-emptive kow-towing, sometimes even by closet members of the Communist party is bad enough, but when China itself is so decentralised and divided on major policy issues, there is inevitably a range of shoe-shiners peddling different brands. Under such circumstances, there is even a virtue in Tung seeking support from Beijing in controlling interests in neighbouring Guangdong province that want a larger slice of Hong Kong's economic pie. He will certainly need powerful friends in Beijing if he is to control the Chinese armed forces doing business in Hong Kong or the mainland "red chip'' companies who are muscling in on lucrative Hong Kong business by advertising their high-level contacts in powerful Chinese circles.

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These are all very difficult challenges for Hong Kong. The only way to ensure success is for the people of Hong Kong to try much harder to take their fate in their own hands. But even if they succeed in persuading Beijing that a Hong Kong "that can say no'' is in China's interests, Hong Kong will still face the daunting task of staying competitive. If the people of Hong Kong are fortunate enough to be allowed to face that challenge, then at least they will do so in the company of the other "tiger economies'' of Pacific Asia.

Gerald Segal is a senior fellow at the International Institute for Strategic Studies and director of the Economic and Social Research Council's Pacific Asia Programme. He is the author of The Fate of Hong Kong and co-editor of China Rising.

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