(This essay was published in Hong Kong Economic Journal on 5 February 2014)

 

Why have the welfare states among the rich countries of the West, which transfer on average some 25% of GDP from the rich to the poor, still failed to alleviate poverty? And why has inequality widened in recent decades? The liberals in these countries – intellectuals and politicians – continue to argue for more public transfers. But if income redistribution could solve poverty, should it not have been solved by now?

 

This illusion about income redistribution is the key reason why so many rich economies have become straddled with public debt – in some countries it approaches 100% and even 200% of GDP.

 

The process of public debt escalation is not difficult to comprehend. Higher expenditures result in higher tax burdens. The taxpayer becomes increasingly unwilling to finance more government expenditures through taxation.

 

Politicians then begin to issue public debt and ask taxpayers to finance only the interest payment, which is a much smaller amount. So as expenditures increase, so does public debt. As public debt mounts, governments seek to pay off the debt through inflation. Sovereigns in the past used inflation to finance unpopular wars. Today, in addition, they finance “wars on poverty”.

 

Diminishing Returns to Welfare Transfers

 

Sixty years ago many rich democracies believed in these liberal ideas, but today there are many more skeptics. There are two reasons why welfare and transfer spending is highly inefficient. Most spending is not through cash transfers, but in identifying recipients and administering the program. These costs are not trivial, but they are very likely to be much lower than the cost of operating in-kind transfer programs.

 

When a government provides a social service, either directly or by funding non-government social service providers, the major expenditure is not on the purely administrative cost of dispensing funds to the providers and monitoring their activities, but the employment cost of hiring these providers. Does a social service provider that costs $20,000 to hire produce enough value for their clients to be worth this upkeep?

 

Very few analyses of the benefit-to-cost ratio have been done in Hong Kong. If we analyze this ratio for Hong Kong’s public housing program in the period 1976-1996, it comes out at 60-75%. Is the ratio for other social programs higher or lower than this? I would be surprised if they were much higher on average. Given the law of diminishing returns, the ratio will most likely fall as the number and scale of the programs grow. So the larger the welfare state, the more inefficient it becomes.

 

With low benefit-to-cost ratios and diminishing returns, it is not surprising that big welfare states have failed to alleviate poverty. A cynic would even assert that the main beneficiaries of the welfare state are the service providers, underwritten by the taxpayer. As is often observed, the most ardent advocates of the social welfare are the service providers rather than the beneficiaries – their clients. In an open society, service providers are often well placed to garner political votes.

 

Welfare everywhere has always gone hand in hand with the political vote. Both factors have been growing in Hong Kong recently. But Hong Kong’s poverty has deeper causes than a welfare state and income redistribution measures can address, especially as these measures have not proven to be successful in other countries over the past half century.

 

Let me explain what I see as Hong Kong’s true poverty problem. It is better described as the problem of “near poverty”.

 

Poverty and Near Poverty

 

Only a very small percentage of Hong Kong people are actually destitute – these are the elderly women who have to pick cardboard boxes for a living or the new immigrant who has lost her husband and ends up without shelter and several dependent children. These stories are true and make headline news, but they are a small fraction of the population. I certainly do not believe that the 1.29 million persons below the poverty line or even half that number is destitute in any meaningful sense of the word.

 

But I do think a very large percentage of the families do not have a sufficient income to be comfortable. In fact, I believe many if not most families near the median household income of HK$20,000, and most of those below it, have very little in the way of savings. They often cannot afford to send their children to good schools in other districts and cannot afford to see a doctor in the private sector even on occasion. These are the people in “near poverty”. If the household is young, there may be a chance that with some luck their economic condition will improve provided they work hard.

 

Most of the “near poverty” families have meager savings and are highly subject to economic vicissitudes. They are often in debt and failing to make ends meet. Economically they are on the brink of bankruptcy though not officially or legally declared to be so. Their health is often poor causing them to have low incomes and sometimes it is low incomes that cause their health to be poor. They cannot afford to send their children to university except at a subsidized place in Hong Kong’s system, which provides for only about 20% of all Hong Kong youths. Many if not most of the wealthy send their children abroad for education.

 

The Property Ownership Devide

 

Households in “near poverty” are probably close to half of Hong Kong’s population. Their condition gives them much less to look forward to than similarly placed families in their parents’ generation. It is not that they are worse off by comparison, but they seem to face diminished aspirations for themselves and their children. One question that needs to be examined is the cause of this; another is the effect. A third is what if anything could be done to raise the median income significantly. This is another way of seeing growth – Adam Smith’s way.

 

One cause of rising economic inequality has been the run of enormous shocks experienced by Hong Kong people in the past three decades and the simultaneous transformations that have taken place in China and the world. The net result has been huge disparities in income and wealth over time.

 

The distribution of human capital among individuals has widened even though median income has not risen. Ageing and rising divorce rates have caused household income inequality to increase at a time when increasing property prices mean property ownership is far from universal.

 

Those with property in Hong Kong have become the new “haves” and the rest “have-nots”. Never has society in Hong Kong become so neatly divided by a single factor. The “haves” are not a small group. About half of the households in Hong Kong own some property. But given high current property prices and high down payment requirements, very few “have-nots” can hope to become “haves” by working hard and accumulating savings. As a consequence, the gap in incomes and wealth is perpetuated and society is increasingly divided.

 

Of course not everyone who owns property has seen a huge appreciation in its value. Although many property owners have been able to leverage on the initial capital gains to achieve even further gains, some are only marginally better than the “have-nots”. They have very low incomes, their sole property is not worth much, and it is occupied as a domestic premise. These marginal property owners are probably “near haves” only.

 

High property prices are driven by demand in a city where the provision of new land involves a slow and complex process (this is an area that needs a total policy overhaul – an issue I have addressed in previous articles). This demand is profoundly affected by transformational changes that have taken place in China and in the world over three decades, and that require a government response that is equally transformational. Unfortunately, our government appears to have no stomach for this and holds onto old rules and policies that have resulted in Hong Kong becoming more economically and socially divided.

 

Property as Loan Collateral

 

Another cause of rising economic inequality in Hong Kong, and thus of poverty or “near poverty”, is the rapid advances in technology that have increased the demand for highly educated persons and reduced the demand for manual laborers. The growth in service jobs also favors highly skilled talents. Unfortunately, investment in higher education in Hong Kong has pretty much stagnated in the past two decades at a time when the demand for highly educated persons is rising rapidly everywhere.

 

Hong Kong now has a shortage of highly educated persons and this, in my view, has driven new opportunities away and restricted an important channel for upward mobility. Hong Kong’s low unemployment rate is nothing to be proud of. Our low-skilled workers are kept employed by visitors from across the border, but mass commercial tourism does not produce a high value-added economy.

 

Starting a new business in Hong Kong has become more difficult for those without skills and capital. Many have to venture into the Mainland where barriers to entry remain high and business risks are considerable. Getting financing has become equally difficult. Banks have traditionally been reluctant to lend to new businesses without collateral. In Hong Kong collateral means property and this means the “have-nots” and even the “near haves” are denied financing.

 

The Chief Executive in his Policy Address relates the story of a young Hong Kong entrepreneur he met on one of his visits to the Mainland two months ago. This successful entrepreneur had started a business in Guangxi, managing a supply chain of imported red wine, coffee and other food items. What struck me as the most significant point of the story is how he financed his business. Obviously he had no help from any bank. Rather, “He refinanced his property, dug into his savings and borrowed money from his relatives…”

 

The Policy Address concludes, “This particular story shows us that with determination and tenacity, and by capitalizing on the opportunities at home and abroad, young people can build a promising career in various markets and industries, new or traditional.” I think this is correct, but this young man had one thing in his favor – he had property to start with that he could refinance at some opportune time. As a property owner he had a better chance of turning himself into one of the “haves” with “determination and tenacity”.

 

Entrepreneurs from Hong Kong often financed their business investments in the Pearl River Delta in the 1990s by refinancing properties in Hong Kong, when no banks in either Hong Kong or the Mainland were willing to give them a business loan. Access to collateral-based lending is an important driver of entrepreneurship in Hong Kong. When half the people of Hong Kong do not own properties then we have effectively switched off credit to half of Hong Kong: the “have-nots”. This kills another channel for upward mobility.

 

Families in Near Poverty

 

The wealthy in Hong Kong and those elsewhere use their wealth to assure the prosperity of their children, in part by investing in their health and education. If the poor and the near poor do not have the resources or opportunities to help their children gain access to human capital investment, then society will suffer. Many talented poor boys and girls will not be able to realize their potential, meaning a very large actual and potential labor force is underutilized.

 

Equalizing opportunities across families has to be an important part of alleviating poverty. The benefits will not be limited to the poor alone. Many in the middle class today feel they are in near poverty or sinking into it. They are not sure if they will own their own homes and if their children can have access to quality education. The “have-nots” living in public rental housing feel there is no escape from near poverty. Many of them have broken families and are single dependent parents. For them, the hope is that their children can get into public housing; sadly enough, getting divorced apparently improves their chances.

 

People who are poorly educated, unhealthy, brought up in broken families, exploited by unscrupulous sellers of goods and services, preoccupied with making ends meet, in and out of bankruptcy, and constantly worrying about the household budget are unlikely to be productive workers. All of society suffers as a result. They are also unlikely to be competent participants in the political process, as voters, because they lack both the leisure and the education to become even minimally informed about public matters.

 

The poor have been defined as having household incomes below 50% of the median income. This is hardly an adequate description of poverty and gives, at best, a partial and probably misleading picture of Hong Kong’s poverty problem. Poverty is too complex a process to be reduced to a statistic. Many of the 1.29 million people below the poverty line have already received considerable help from government for decades. More than half are beneficiaries of the public housing program and others benefit from other welfare schemes. But they are still poor.

 

Some believe that the social safety net should be expanded for those in poverty. At best this would reduce the number of people found below the poverty line for a while. The real test of poverty alleviation is whether, at the end of the day, a family succeeds in lifting itself out of poverty through increasing productivity and exits the social safety net. If you are dependent on the state in a democracy, you merely have the right to vote for your dependency.

 

Others believe the social safety net should be removed to increase the incentives of the poor to work hard and improve themselves. This is unrealistic because it fails to show how the poor can improve their productivity and gain dignity and sophistication to vote for their personal freedoms, and to live self-fulfilling and responsible lives.

 

Policies for Addressing Near Poverty

 

So what is to be done? These are the most promising measures:

 

(1) Make a large investment in education, especially early childhood education so that families can have faith in a better life for their children. This will help keep families together with a common goal and offer a better chance of creating a future generation of happy and responsible individuals.

 

(2) Expand higher education opportunities for young people. If Hong Kong is to provide good learning opportunities and build a diversity of skilled talents for its future as an international economic center, it would be far better to provide scholarships for students without means to study in overseas institutions of their choice than provide more Associate Degree places that would articulate into local universities. Scholarships are unlikely to be more expensive and would be far more welcomed by families in Hong Kong worried about diminishing prospects for their children.

 

(3) Rebalance welfare spending on the elderly towards meeting the needs of children and families. The consequences of rapidly rising divorce rates, especially among the poor, demands this change. People are much less likely to live unmotivated and irresponsible lives if they do not grow up in broken families.

 

(4) Avoid allowing the Low-income Working Family Allowance to create incentives for divorce.

 

(5) Minimize incentives for divorce through the allocation of public rental housing. A good approach would be to unify the public rental housing program and the Homeownership Scheme into a single program to supply affordable subsidized homes with full private ownership rights. There is strong empirical evidence that there are more divorced households among families that are renters than homeowners, by 50-60% (see my previous essay on “Divorce, Inequality, Poverty, and the Vanishing Middle Class (II)”).

 

(6) Substantially expand medical care services in the interest of all individuals, but especially the elderly. Promoting medical care services is not only a good investment in the health of local residents, but also in career opportunities for young people. The demand for medical services will grow by leaps and bounds in the coming years not only because of Hong Kong’s ageing problem, but China’s as well. Reforming and improving China’s medical care services will be a huge challenge and Hong Kong can create enormous value for its people and for the city by investing in this field. A biomedical technology industry may become a promising spinoff.

 

A crucial factor in initiating this virtuous circle is to build more hospitals and train more doctors and nurses. In the short-term, it will be necessary to alleviate the shortage by making it easier for medical doctors trained abroad to work here. A first step would be to allow local residents trained abroad to practice on a probationary registration for two years, after which they could convert to full registration. This would be in the interest of the people of Hong Kong. A proposal to develop a subsidized voluntary insurance scheme at best promises to re-arrange healthcare financing; it does nothing to check the cost of rising medical services, which depends in the final analysis on the supply of medical and healthcare professionals.

 

(7) Curtail the rising cost of land and property. This is also crucial for Hong Kong’s economic future. Studying the development of Lantau Island is a good idea, but this is a planning proposition that will take years to come to fruition. While working on this plan, it would also make sense to consider how to quickly overhaul policy practices governing the development and redevelopment processes in Hong Kong to substantially reduce transaction costs and speed up the supply of land and property.

 

The primary reason for poverty is that people are unmotivated to work? due to, for example, poor health, poor education, poor work habits, and limited opportunities for good jobs. To change this, they need a goal worth reaching for, not a drip to keep them just alive. Income redistribution has its role, but without economic opportunities we will only end up with a crowded ward full of sick patients. Poverty has to be solved by economic growth. Income redistribution without economic growth cannot solve poverty. In the long run, it will break the back of our local economy and our public finances. Hong Kong does not have a big poverty problem of poor destitute people, but a huge problem of near poverty households that do not see a future for themselves and their children.

 

References:

 

Yue Chim Richard Wong, “Divorce, Inequality, Poverty, and the Vanishing Middle Class”, Hong Kong Economic Journal, 1 January 2014

 

 

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

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