(This essay was published in Hong Kong Economic Journal on 6 November 2013)

 

Today I begin a new series of essays on how to rekindle Hong Kong’s magic. This is my third series on the city and, with the two earlier series on “Hong Kong’s Deep Contradictions” and “Has Hong Kong Lost Its Magic?”, it forms a trilogy that completes my thoughts on my favorite city.

 

As Hong Kong pads her way through a changing global economic landscape in which China is now an emerging power and our sovereign country, she has become troubled by disagreements over her identity and future place, both in China and the world. She is therefore unsure of her role. This follows over half a century of incredible success where standards of living and personal freedoms grew spectacularly under an umbrella of political stability and peace.

 

Domestically Hong Kong has been grappling to respond to some very challenging problems in addition to questions about her identity. On the economic side, these include: (1) stagnating standards of living among low income individuals, (2) widening income and wealth gaps, (3) slow progress on economic innovation in many of our industries, (4) an increasingly inward economic focus after manufacturing moved across the border and was replaced by services, and (5) challenges to the city’s time tested policies that uphold free markets and limited government.

 

Rapid demographic change and the transformation of the family are also presenting many new challenges in society: (1) an ageing population, (2) a labor force that is no longer growing, (3) population quality that is falling behind other metropolitan centers, (4) an alarming increase in family breakups, (4) upward social mobility that appears to be faltering, (5) hopes for homeownership vanishing among many first-time home buyers, (6) quality education opportunities for children appearing to be beyond the reach of many young parents, and (6) growing fears that the health care provision will become inadequate when it is most needed in future.

 

In politics, our ability to make sound political choices is hampered by (1) a search for a workable political system that continues to be out of reach, (2) increasing disputes among a growing number of minority views and interests, (3) a public policy agenda that is increasingly fragmented and defies aggregation, (4) a nagging identity crisis that is propelling a once open society to turn protectively inwards and breed nativist tendencies, and (5) a readiness to defend minor and secondary concerns at all costs that is eclipsing Hong Kong’s once legendary pragmatic ability to adapt in the face of adversity and seize emerging opportunities. These are not conditions that a nascent democracy can rely upon to grow and mature. Rather, they are circumstances that populist demagogues have often exploited at the expense of broad public interests.

 

Shared Challenges

 

These challenges may appear intractable, but as a student of the Enlightenment, I have never lost faith in human reason. Hong Kong’s post-war economic miracle shows how our future can be even brighter in the new era that is upon us. After World War II, many post-modernists were shaken by the economic and financial crises, wars and rebellions, political and social instabilities they witnessed or experienced. They lost confidence in reason altogether and took refuge in the comfort zones of inward looking, self-contrived cultural and social communities. I do not share their views or feelings. I shall explore how Hong Kong can take on its challenges head on in a coherent and strategic manner.

 

My narrative begins with a comparison with Singapore. Many of the external and domestic challenges that Hong Kong faces are also present in Singapore. However, as we shall see, Hong Kong’s challenges have been much more formidable. Comparing ourselves to Singapore can help us to clear our thoughts, though, and set proper benchmarks for meeting the difficulties we face.

 

Both cities have faced problems of income inequality. Worldwide competition has led manufacturing jobs to migrate to economies where less skilled labor is abundant and wages are low. Competition in the global marketplace often means that the real wage of less skilled workers in the advanced economies tends to remain unchanged year after year. Residents in Singapore and Hong Kong with low-level skills have seen little wage growth for years if not decades.

 

The wages of the less skilled have fallen increasingly behind the rest of the population not only because of the effects of economic competition, but also because of modern day technological progress that is biased in favor of skilled workers. The spread in returns to education for more educated versus less educated workers has grown in the advanced economies in the past 30 years. This has widened the wage gap between skilled and unskilled workers. Observed income inequality has therefore grown.

 

On a worldwide scale, parents in the middle-income and advanced economies are also spending increasing effort to enhance their children’s educational opportunities and outcomes. This is observed at the higher education level in the competition for the best university places, at the pre-school level, and at all other levels, including competition for participation in extra-curricular activities. Income dispersion has been further exacerbated because of unequal access to these opportunities for underprivileged families and also underinvestment in education by many societies.

 

Homeownership and Intergenerational Mobility

 

Singapore has responded to these changes by intervening in the market to attract and retain manufacturing industries, and promoting technological advancement to create quality jobs. It has also imported skilled immigrants and invested in education to sustain growth and productivity. These policies have helped GDP per capita growth, but they have not been able to stem the increase in wage and income gaps between skilled and unskilled workers. These gaps have become a widely observed phenomenon in many advanced economies over the past three decades.

 

Stagnant income growth at the low end of the skill spectrum has made it more difficult for young and less skilled workers to become homeowners. This is true in both Singapore and Hong Kong where property prices have risen more rapidly than elsewhere because of the difficulty in supplying land. A global low interest rate has created a macroeconomic environment that has fuelled property price inflation in both Hong Kong and Singapore, with great impact. As a result, those without property have not been able to share in the prosperity from property price inflation and they have found themselves increasingly left behind. The situation is much worse in Hong Kong where homeownership rates are about 50% compared to Singapore’s 92%.

 

Young men and women bemoan their inability to save enough to get on the homeownership ladder. Some even claim that this is delaying marriage and child-bearing. In Hong Kong, probably an even more important factor that is delaying marriages is the rapidly rising divorce rate. This has also increased the demand for housing and most likely contributed to the rise of sub-divided housing units in the private residential market.

 

Divorce rates in Singapore have also been rising, but they are much lower than Hong Kong’s. In 2012, there were 7,727 divorces in Singapore (equal to 1.9 divorces per thousand Singaporean residents) compared to 21,125 in Hong Kong (equal to 3.0 divorces per thousand Hong Kong residents). The reason why this is the case should be carefully studied. Hong Kong’s higher divorce rate is a worrying phenomenon because of its potential consequences on the transmission of poverty across generations. Divorce rates are typically higher among the poor and the adverse effects on children’s development are often multiple, permanent, and large.

 

Human Capital Shortage and Inequality

 

Another common challenge is that both Singapore and Hong Kong have ageing populations and therefore ageing workforces. Fertility and mortality rates are low and have been falling. The situation is far more serious in Hong Kong. In 2010, the elderly dependency ratio defined as the ratio of the population aged 65 or above to the working age population of 20-64 was 0.123 in Singapore, but 0.187 in Hong Kong. According to projections made by the United Nations, this ratio is projected to peak around the year 2065 at about 0.5 in Singapore and 0.8 in Hong Kong.

 

Both cities also suffer from a labor shortage problem but it is much worse in Hong Kong, especially for skilled workers. This stems from a number of factors. First, Hong Kong has invested less in education. Second, the emigration of skilled workers in the 1980s due to uncertainty about the future change of sovereignty depleted the ranks of Hong Kong’s skilled labor force. Third, barriers erected to prevent skilled workers from entering Hong Kong in some fields and professions have not helped.

 

And fourth, Hong Kong has been especially adversely impacted by the large inflow of unskilled immigrants from the Mainland, mostly through cross border marriages concentrated among the less skilled members of society. In the 35 years since 1978, Hong Kong has received some 1.6 million immigrants from the Mainland into the city.

 

Singapore’s Social Welfare Path

 

All these factors have combined to widen the wage gap between skilled and unskilled workers and to starve Hong Kong of a much-needed boost in the quality of its population. Lately the tide has turned a little as a growing fraction of cross border marriages are beginning to occur among the more skilled and better educated. But there is still a large chasm to bridge.

 

Singapore by contrast has attempted to offset the impact of its ageing population on employment growth by importing foreign workers and attracting new immigrants. In the decade to 2014, Singapore will have had the biggest employment growth among 33 of the most advanced economies. However, while immigrant workers create growth, they also put pressure on domestic housing resources and create greater anxiety among the less skilled and the young.

 

In the face of these rising social pressures the People’s Action Party suffered a significant loss of political support in the 2011 elections. This prompted the Singapore government to re-think its development strategies. In August 2013, Prime Minister Lee Hsien Loong announced a strategic shift in Singapore’s approach to nation building at what he claims to be a “turning point” in the history of the nation. The most important new policies aim to enhance healthcare, education and housing.

 

First, the government will do more to give every Singaporean a fair share in the nation’s success through its new housing policies. Families earning S$1,000 or above will be subsidized to own their own unit at a price delinked from that in the resale market. Currently 92% of Singaporeans are already homeowners so the government’s challenge is much less than that of Hong Kong’s.

 

Second, the Singaporean government will strengthen social safety nets in healthcare and provide universal coverage with more generous benefits supported by higher premiums. Subsidies will be provided to those who cannot afford the higher premiums.

 

Third, the government will also keep the upward mobility path open to all so that even the less advantaged will have a good head start. More subsidies will be added to the education savings accounts of every child aged 7-16. An additional 20,000 pre-school places will be created to enhance early childhood education.

 

Some local commentators in Hong Kong have likened Singapore’s bold steps as a slap in the face of our government’s more hesitant approach in dealing with our problems. But other commentators believe Singapore’s further plunge down the path of social welfarism is inappropriate for free-market and self-reliant Hong Kong.

 

Lee Hsien Loong himself is not unaware of the significant risks of these changes and he gave examples of countries that have tried to implement similar policies with the best of intentions, but ended up with undesirable and unintended consequences. Finland has had 20% youth unemployment despite comprehensive protection for workers and a good education system. The US has the highest healthcare spending in the world, but health outcomes are worse than many advanced countries.

 

Lee insists that his government will do more for those with low-incomes, but will try not to undermine their self-reliance. He warned against saddling future generations with debt so as to pay for present consumption. This means he wants Singaporeans to pay for these expanded social safety nets through higher taxes. For Lee, this strategic shift is a calculated risk. The Singapore government will have to tread carefully and beware of the pitfalls. As the head of an elected government he has no choice.

 

Will Hong Kong travel down this social welfarist path someday? The social and political pressure is certainly mounting. It is likely that in 2017 Hong Kong will have a popularly elected Chief Executive, but the legislature is likely to behave in the same unchanged, fragmented and divided manner. Hong Kong’s ageing population is and will become much larger than Singapore’s, making the prospect of a social welfarist path even more costly.

 

Ageing Population and Public Expenditure Trap

 

One problem is that thanks to Hong Kong’s low tax rates, the majority of eligible voters do not have to pay taxes. Hong Kong’s share of non-tax paying voters will keep on growing for the rest of this century because the elderly dependency ratio will keep on rising until it peaks at 0.8 around the year 2065 according to projections made by the United Nations. This ratio will continue to remain close to 0.8 until the year 2100, which is the last year of projections. Hong Kong will become a city where septuagenarian and octogenarian voters will dominate political agendas for an entire century if our population policy does not change.

 

Singapore has always had a Central Provident Fund that offers low returns and compels workers to contribute a gargantuan share (currently 36%) of their income to support a social safety net. It also has in place a broad based consumption tax to make its residents pay for the higher premiums of an enhanced social safety net. None of this is available in Hong Kong and it is unlikely that such institutions can be put in place soon enough to support a more generous social safety net. It is also not desirable for Hong Kong and will be resisted forcefully by a large segment of our society.

 

Hong Kong’s population challenge is in a nutshell the ageing of the post-war baby boom generation. This generation is a demographic anomaly in the population age pyramid not found anywhere in the developed world. Its appearance can be traced to the huge influx of people that swelled Hong Kong’s population from 600,000 in 1945 to 2.1 million in 1951. This first generation of immigrants had a high fertility rate, but the second generation (i.e., the baby boom generation) had a much lower fertility rate. These two factors together created a huge bulge in Hong Kong’s population age pyramid.

 

The baby boom generation is now entering retirement age. Life expectancy of this generation is also unusually long and is putting increasing pressure on healthcare resources and retirement incomes. Politically they will have the largest voice in society for a very long time to come. Democratic elections will actually guarantee it.

 

It is doubtful that any significant fraction of these grey-haired voters can be counted upon to act with a strong sense of fiscal responsibility at the ballot box. They demand more public spending, but have no incomes that are taxable. Surely smart ambitious populist politicians will be shrewd enough to urge them to vote for increases in public expenditures and ignore how the working minority, a combination of skilled and unskilled workers, shall be made to foot the bill. “Power to the Grey Panthers!” will be their rallying call. This appears to be the same disastrous recipe that has led to deficit spending and public debt accumulation in the West and Japan. In Hong Kong they are concentrated enough to become obvious to all.

 

Some say deficit spending will not be permitted under the Basic Law. Perhaps, but politicians that cannot raise taxes to pay for public expenditures will simply pass laws and regulations to compel private corporations to fund them in order to circumvent constitutional constraint. Regulation induced transfers is an alternative to tax induced transfers. For example, the law can compel employers to fund health care and housing mandates. Regulatory intervention is an even more damaging alternative to taxes because it raises the cost of doing business a lot more.

 

The minimum wage legislation is another example of regulating induced income transfers. Instead of taxing the public to subsidize low-wage workers it compels employers to pay low-wage workers directly. Although the minimum wage does not transfer income to the non-working population directly, if many low-wage workers are supporting non-working elderly persons then it is in effect an indirect transfer to the non-working elderly. Hong Kong’s competitiveness will inevitably be eroded as regulations proliferate to fund those expenditures that the public purse is unwilling or unable to pay for. The executive and legislative sides of government are destined to lock horns over the introduction of various kinds of regulatory controls.

 

Hong Kong’s divisive and fragmented political landscape provides the ideal condition for the proliferation of regulatory control. When the pressure on our government to spend more on housing, healthcare, and education is even greater than that in Singapore, and the Basic Law disallows deficit financing, then raising the regulatory burden is the only political solution available. Unfortunately this will have far more damaging consequences on the economy.

 

What is to be done? Can Hong Kong steer a path that allows her to fund the rising demand for public expenditures while promoting economic growth, so that the additional spending is economically affordable and also politically feasible? That question will be addressed in my next essays.

 

 

First essay in the series on Rekindling Hong Kong’s Magic

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