Today, I wish to share with you a few thoughts about Hong Kong's path towards a knowledge-based economy. I will also talk about Hong Kong's role in our nation's knowledge economy. And, of course, there is the topic of constitutional reform that is reaching yet another critical juncture. More about that later.

First, Hong Kong as a knowledge-based economy.

It was back in 1966, that the management guru, Peter Drucker, first introduced the concept of a knowledge economy in his book, "The Effective Executive".

In the book, Mr Drucker described the difference between the manual worker and the knowledge worker. Manual workers, he said, work with their hands and produce goods or services. In contrast, knowledge workers work with their heads, not hands, and produce ideas, knowledge, and information.

Some 44 years have passed since the publication of "The Effective Executive".

We have gone through the golden era of the industrial age. Thanks to automation and advances in production technology, the cost for producing physical goods has decreased significantly. The global economy has flowed towards abundance, and companies have to move upstream in search of new opportunities.

In 2001, another management guru, Seth Godin, wrote in his popular e-book, "Unleashing the Ideavirus" about the importance of ideas in today's world. He observed that 20 years ago, the top 100 "Fortune 500" companies either dug something out of the ground or turned a natural resource into something tangible that you could hold.

Today, only about one-third of those top 100 companies produce tangible goods. The rest sell ideas, instead of processing resources. Some offer services such as healthcare and telecommunications. Even for companies that sell physical products, such as medicine, their most valuable assets are the intellectual properties for making the goods.

This trend has created a gigantic force driving us towards a so-called knowledge-based economy. The change is upon us, and we must act fast to seize the opportunities.

In his Policy Address last October, our Chief Executive outlined his vision for Hong Kong to enhance our competitiveness and continue evolving into a high value-added, knowledge-based economy.

Apart from the four traditional pillar industries - namely financial services, tourism, trade and logistics, and professional services - we are placing particular emphasis on six additional knowledge-intensive industrial areas. You will be familiar with these industries, but allow me to repeat them, because they are important to our sustainable economic growth.

They are education services, medical services, testing and certification services, environmental industries, innovation and technology, and cultural and creative industries.

The first essential ingredient for a knowledge-based economy, no doubt, is knowledge itself. While it is never easy to quantify knowledge, the wealth of knowledge in an economy is closely linked to the education level of the workforce, or what we often refer to as human capital.

Over the years, Hong Kong has been doing a lot to enhance our human capital. Education expenditure has increased by 18% over the past 10 years. It now takes up the largest share of recurrent government expenditure.

We are continually improving our education system. Recent examples include the new academic structure for senior secondary and higher education, as well as small-class teaching in primary schools.

We have also fostered the development of higher education by launching the matching grant scheme. Over the past seven years, more than $10 billion of additional resources has been secured by tertiary institutions. This enables them to enhance teaching and research capacity.

In the information age, the diffusion and use of information and knowledge is as important as its creation. The success of a company, and, indeed, an entire economy, relies on how effectively knowledge can be gathered and put to use.

Hong Kong is fully geared up to facilitate the flow of information and knowledge. We have a world-class telecommunications network that connects us with the rest of the world.

According to the Fiber-to-the-Home, or FTTH, Council - a multi-national industry association - the household penetration rate for FTTH and related services in Hong Kong is 33%. Only South Korea and Japan have higher rates globally.

With first-class hardware as well as our personal freedoms, including freedom of speech and free flow of information and ideas, knowledge can be exchanged here without hindrance.

Hong Kong also has other core attributes that promote the development of a knowledge-based economy. These include a simple and low tax regime; high-quality services and free flow of capital with no foreign exchange controls. We also have a stable and fully convertible currency as well as a free and open economy buttressed by the rule of law and an independent judiciary.

This is important for our economy because the free flow of ideas and knowledge often culminates in new technology. The Government attaches great importance to the promotion of R&D. We fully appreciate that innovation and technology are key drivers of our economic growth.

We are committed to providing a favourable eco-system to enhance the development of this important sector. Such efforts include providing first-class technological infrastructure through the development of the Science Park and Cyberport.

We have the $5 billion Innovation & Technology Fund, which finances applied R&D projects conducted by universities, R&D institutions and companies. We also have five specific R&D centres to promote research work in focused technology areas.

In my Budget in February, I reinforced our efforts in promoting R&D by: First, supporting the development of Science Park Phase 3. Secondly, enhancing support for inventors under the Patent Application Grant. And third, launching the $200 million R&D cash rebate scheme that started in April.

The testing and certification industry is another sector in sharp focus. Hong Kong has clear advantages in developing this industry. We are located at the doorstep of China, which has a reputation as the "world's factory".

Our services industries are also highly regarded globally. We are ready to capitalise on the huge opportunities in providing quality certification and product testing services for Mainland enterprises.

We set up the Hong Kong Council for Testing & Certification in September last year to spearhead the development of the industry.  The council has outlined the blueprint for development. This includes making general improvements to accreditation services and factors of production affecting the industry. At the same time, the council is focusing on four trades with special business potential, namely Chinese medicine, construction materials, food and jewellery.

Hong Kong also has an edge in developing various creative industries, from advertising to motion pictures, and from design to digital entertainment. Indeed, creative industries alone add more than $60 billion worth, or 5% of value, to our GDP each year. There are over 32,000 establishments that are related to creative industries, employing more than 176,000 people.

A dedicated office, "CreateHK", was set up in June 2009. Its raison d'etre is to better co-ordinate the Government's drive in developing creative industries. "CreateHK" also supports a more effective response to industries' demands and provides a one-stop service for stakeholders. A $300 million CreateSmart Initiative was also established to support the development of creative industries.

Different kinds of support have also been provided to medical services, education services and environmental services. Such initiatives aim to create the right market conditions. Areas where the government can lend a hand include ensuring adequate land resources and nurturing talents. Perhaps most important, we can seek to enhance business co-operation with the Mainland to enable enterprises to tap into the huge market there.

Our CEPA with the Mainland is a good example of how we open doors to markets across the boundary. This includes pilot initiatives with Guangdong Province to speed up the process.

With all the ingredients I have just mentioned, our success will still depend to a large extent on how far we can synergise our development with that of our nation.

Indeed, Hong Kong has much to offer the Mainland in its transformation towards a more services-oriented and knowledge-based economy.

The days when the Mainland could compete on low costs and sheer quantity alone are fast disappearing. The Mainland too, is moving up the value chain with services and other high value-added industries growing fast with support from the Central Government.

Despite growing competition, both Hong Kong and the Mainland have much to gain from closer collaboration. Co-operation between us will speed up the Mainland's transformation to a knowledge-based economy and, in turn, open up new opportunities for businesses in Hong Kong.

The establishment of the Shenzhen-Hong Kong Innovation Circle and the joint funding schemes with Guangdong Province and Shenzhen are notable examples.

We have successfully invited DuPont to locate its global thin-film photovoltaic business headquarters and research centre at the Hong Kong Science Park. Its manufacturing facilities are in Shenzhen. Such collaboration brings investment and talent to Hong Kong, new technology to the Mainland and opportunities for all the firms involved.

This year, all eyes are on Shanghai with the city hosting the World Expo. Hong Kong is participating at the Expo under the theme: Hong Kong - Potential Unlimited. We have a pavilion and we are taking part in the Urban Best Practices Area Exhibition. Our goal is to showcase the creative side of Hong Kong to visitors from around the world.

The Government has also been working with local creative industries to organise a rich variety of events in Shanghai during the Expo period. These include activities that promote creative and artistic co-operation between Hong Kong and Shanghai.

Another area where Hong Kong entrepreneurs can contribute to China's economic development is through their international exposure and experience in exploring overseas markets.

Hong Kong has established a solid business network in different parts of the world, and also gained the trust of overseas buyers by ensuring high quality goods and reliable services. Mainland enterprises can leverage on our reputation by collaborating with Hong Kong companies to explore overseas markets.

It would be impossible for me to speak to you today without addressing the current hot topic of constitutional reform.

The Government recently put forward a package of proposals for the methods for selecting the Chief Executive and for forming the Legislative Council in 2012.

The package was formulated after extensive public consultation. An important conviction of the proposals is that we should roll forward reforms in the 2012 elections to pave the way for implementing full universal suffrage. This is also the mainstream public sentiment.

The package of proposals injects new democratic elements into the two electoral methods for 2012 under the framework of the decision of the Standing Committee of the National People's Congress in 2007. The decision by the NPCSC allows for universal suffrage for the Chief Executive elections in 2017 and LegCo elections in 2020. Some of the new democratic elements include:

(i) increasing members of the Election Committee from the current 800 to 1,200. This will provide more room for public participation in the Chief Executive's election;

(ii) increase the members of the four sectors of the Election Committee each by 100, with 75 new seats of the political sector allocated to elected District Council members. All the 117 seats of the District Council subsector will be returned through election from among elected District Council members;

(iii) increasing the number of seats in LegCo from 60 to 70. The number of seats returned by geographical constituencies and functional constituencies will each be increased by five to 35. All the five new functional constituency seats and the existing District Council Functional Constituency seats will be returned through election by elected District Council members. As a result, forty-one seats - close to 60% of all seats - in LegCo will be returned through geographical constituency direct or indirect elections; and

(iv) The six District Council Functional Constituency seats will be returned through election from among elected District Council members under the "proportional representation system". The seats can be allocated in a fair manner, where political parties or groups of different sizes and independent candidates will all have a chance to get elected.

Regarding the universal suffrage model for the Chief Executive, the NPCSC decision has already made it clear that in selecting the Chief Executive by universal suffrage, the nominating committee might be formed with reference to the current provisions regarding the Election Committee in the Basic Law.

If the composition of the Election Committee for 2012 can be dealt with properly, it will facilitate the transformation of the Election Committee into the nominating committee when universal suffrage is implemented in 2017.

There has also been wide public concern about the future of the District Council appointment system. The Government adopts an open and constructive attitude towards abolishing the District Council appointment system. After the passage of the proposed package for the two electoral methods for 2012 at LegCo, the Government will implement the proposals as soon as possible.

The current term Government has only been authorised by the NPCSC to deal with the two electoral methods in 2012. However, we have already put on record the different proposals for implementing universal suffrage put forth during the public consultation.

We would also recommend the next term Government to follow up and consider the relevant proposals seriously.

The Government will strive to obtain public support and also LegCo's endorsement of the package of proposals before the summer recess of the LegCo in July.

Some people have cast doubt on Hong Kong's ability to transform into a truly knowledge-based economy. There are also different views in our community on the pace of democratisation in Hong Kong.

Different opinions are part and parcel of living in a free and open society such as ours.

While respecting different views, it is time for us to reach a consensus on the topics I have covered today so that we can continue to move toward our ultimate goals. We are well aware that standing still has never been, and will never be, an option for Hong Kong.

Thank you for listening. And thanks to you all for your sound advice over the years and commitment to the continued progress and prosperity of our city.

Financial Secretary John Tsang gave this address at the Hong Kong Democratic Foundation luncheon.