(This essay was published in Hong Kong Economic Journal on 26 March 2014)
The ageing of Hong Kong’s population is a rapidly approaching, multi-faceted challenge that will be around for many decades to come. How can we meet this challenge and turn it into an opportunity for our future? I showed in my essay in HKEJ 2014-3-19 that on public health care expenditure alone, an ageing population would result in continuous increases in spending until 2060 and this spending would stay high until at least 2100. Clearly, population ageing in Hong Kong will exert enormous pressure on our fiscal budgets for the rest of the 21st century.
This problem is unfortunately perceived by the Hong Kong public as one of poverty and social security. The social welfare lobby has successfully branded ageing as a poverty issue that requires welfare support. Politicians and their allied social advocates and lobbyists often use old age poverty as the raison d’être to support the introduction of a universal old age social pension, which confuses ageing with poverty.
Ageing and the Social Welfare Burden
I believe, however, that neither poverty nor social security are the most important challenge facing Hong Kong’s ageing population; rather, it is health care.
Consider the respective impacts of these challenges on the fiscal budget. Table 1 gives forecasts of future public expenditures on the Comprehensive Social Security Assistance (Old Age Scheme), Social Security Allowance, and the Old Age Living Allowance Schemes as a percentage of GDP. These forecasts are based on the same methodology I used and described in my previous essays published in this column (see HKEJ 2012-5-16, 2012-5-23, and 2012-11-28).
Table 1: Forecasts of Old Age Welfare and Social Security Expenditures as a Percentage of GDP to 2041 and 2100
|Projected CSSA (Old Age Scheme), SSA, OALA expenditures as a percentage of real GDP||2013||2021||2031||2041||2060||2080||2100|
|OALA subject to means tests||1.11||1.46||2.17||2.45||2.93||2.41||2.34|
|OALA without means tests||1.11||1.87||2.71||2.99||3.58||2.93||2.83|
In these forecasts I adjust old age social welfare payments for each year to accommodate a rising average standard of living in line with increases in real GDP per capita. Two scenarios are developed, one based on a means tested old-age poverty alleviation scheme and the other on a non-means tested universal social pension scheme that gives everyone the same payments.
Under a means tested scheme, old age welfare payments will rise from the current 1.11% of real GDP to 2.45% in 2041, and reach a peak of 2.93% by around 2060 before falling off to 2.34% at the end of the century. Under a non-means tested scheme, old age social pension payments will rise to 2.99% of real GDP in 2041, peak at 3.58% around 2060 then fall to 2.83% at the end of the century.
These numbers imply an increase in public spending on old age poverty and social security as a share of real GDP of 1.82% or 2.47%, depending on whether we introduce a mean test. If we narrow the basis to total public spending (which is about 20% of GDP), the share of social welfare spending to supplement the incomes of elderly people would increase by as much as 9.10% or 12.35%. This is a huge jump in public spending, one that does not even include the full range of social welfare payments, such as the recently proposed income support scheme for the working poor. Public spending on these programs is also likely to increase over time as a share of GDP as Hong Kong moves to a more open political system.
Public Health Provision in Crisis
The projected increase in social welfare spending on the elderly is large, but it pales in comparison to public spending on health care. Based on last week’s Baseline Scenario Forecasts, I expect the share of public health care expenditures in real GDP to rise from 2.56% in 2011 to 5.65% in 2041 (see Table 2). This would also peak around 2060 and stay at approximately 7.0% until the end of the century, implying that the share of public health care expenditures in real GDP will increase by up to 4.35%. As a share of public spending, that translates into an increase of 21.75%, which is double the size of the increase in income support for the elderly.
Table 2: Forecasts of Public Health Expenditures as a Percentage of GDP to 2041 and 2100
|Baseline Projections with public health expenditures held at 50% of total health expenditures||2.56||3.4||4.65||5.65||6.85||6.6||7.1|
|Alternative Baseline Projections with public health expenditures held at 70% of total health expenditures||2.56||4.76||6.51||7.91||9.59||9.24||9.94|
These projections assume that government will be able to hold public spending on health care at its recent historical level of 50% of total health care spending. If, however, government cannot achieve this goal, then the impact on budget deficits will be much more serious. The shift of health care costs to the public sector may happen under a number of circumstances – for example, if partial cost recovery is impossible to implement, a proposed market based insurance scheme fails to be adopted, and the rationing of health care services in the public sector is ineffective in the face of rising political pressures from patients, politicians, and other advocacy groups.
If we assume that 70% of total health care expenditures are spent through the public sector, then the share of public health care expenditures in real GDP will rise from 2.56% in 2011 to 7.91% in 2041, a projection almost identical to the forecast of the Working Group on Long-Term Fiscal Planning (see Table 2). Public health expenditures would then peak around 2060 and stay at approximately 9.60% of real GDP until the end of the century. This implies that between now and 2060, public health care expenditures as a share of real GDP will increase by 7.03%. In terms of public spending, this translates into an increase of 35.15% on health care, which is more than 3 times the increase in income support for the elderly. Public health care spending is by far the most threatening component of our fiscal challenge.
Approaching Fiscal Cliff
Combining the fiscal consequences of population ageing on health care and social welfare expenditures implies that public expenditures as a share of real GDP are likely to increase from the present 20% to 28% (2041) under the most optimistic scenario. If we factor in education, housing, and other elements of social welfare spending not included in these calculations, then the figure could easily rise to 30% even under the most conservative assumptions.
This would obviously have very serious fiscal budget consequences. Our present policies and institutions would take us over the fiscal cliff. Worse, they would completely alter Hong Kong’s fiscal foundation of low taxes and limited government, which are pillars of our free society and free economy.
The fiscal reserves we have accumulated today would not even pay for a small fraction of the recurrent fiscal deficits that will last until the end of this century. It is important to note that in making some of these forecasts I do not assume future real GDP will be growing at a low rate. All my growth assumptions continue to be based on Hong Kong keeping its past levels of productivity growth.
When public spending in Hong Kong rises to 30% of real GDP or even higher, then it is no longer possible to maintain a low tax regime. A higher tax rate will inevitably reduce economic freedom and efficiency. It also reduces our competitiveness against other economies.
Some believe that the solution is to broaden the tax base. But broadening the tax base will also hit those who are not currently paying taxes. This is political suicide for any politician in a democracy. Even the most astute and deft politician can at best broaden the tax base only by promising to raise the tax rate for those who are already paying taxes.
So, if public health care and social welfare expenditures have to rise, should we then reduce our spending on other public expenditures to balance the books? Reducing spending on education is unlikely to be a popular choice. Parents in Hong Kong are keen to invest in their children as a means of upward social mobility. Reducing public spending on education hurts the poor more than the rich and has negative consequences for intergenerational inequality.
Investing in educational capital is also the single most important means of raising productivity in Hong Kong over the long-term. It would be economic suicide to reduce the share of public spending on education in order to accommodate rising health care and social welfare spending. If anything, educational opportunities should be expanded to provide 15 years of free universal education for all starting from pre-primary education, and increased access to tertiary education.
Another option, controlling the rate of public social welfare spending, may be economically desirable but it would also be politically very difficult to achieve. Lower social welfare spending is economically desirable because, as we have seen in Hong Kong and Western societies, generous social welfare spending inevitably produces negative work incentives and discourages self-help.
In Hong Kong we now have more people who have decided not to join the labor force for no compelling reason than before. My essay in HKEJ 2014-1-29 showed that the percentage has increased from around 1% prior to the mid-1990s to over 3-4% ever since. This has happened in all age groups and the timing of this change in labor force participation behavior has coincided almost exactly with the surge in public social welfare spending as a percentage of real GDP.
It is also not entirely obvious whether old age income support for the elderly would actually reach them if their children decide to withhold their own support, in whole or in part, in light of government’s largesse. This is a well-known phenomenon known as the substitution effect in economics and has been observed everywhere. Indeed, a legislator in Hong Kong once claimed that the aim of universal old age pensions was to help the adult children of the elderly by making it feasible for them to reduce their parental contributions. Regardless of whether we should help these adult children, isn’t there a better way of helping them directly without using their parents as an excuse? Investing in health care is probably a much better way of helping the elderly. They will then receive the benefits for sure.
Long-Term Fiscal Balance
It appears to me that there are only two policy options for balancing the long-term fiscal budget and meeting the challenge of our ageing population. The first is to adopt an innovative way to fund public housing expenditures. The second is to hold down the share of public health care spending by investing in the training of more medical and health care personnel and admitting some foreign-trained practitioners. Since salaries are the most important component of health care costs, this will help hold down public health care costs.
Let me explain further on housing expenditures. The demand for public housing is increasing rapidly because of two factors. First, the divorce rate has risen rapidly since the mid-1990s, especially among low-income households and those living in public rental housing. This has fuelled the demand for more public housing as divorced individuals remarry and return as applicants to the Waiting List. Second, young households are queuing for public rental housing to improve their chances of getting into the Homeownership Scheme (HOS) as Green Form Applicants, in response to high private property prices that are expected to stay there for the long-term (see my essays in HKEJ 2013-10-30 and 2012-10-24).
These two sources of demand were not foreseen. The government believed rising public housing expenditure would become a thing of the past, and since the late 1990s the share of public spending on housing has in fact been declining. The government probably felt reassured in its thinking because the number of households relative to the number of available permanent housing units has been on average 10% lower ever since the 1990s. But this is a misleading indicator when the new source of housing demand comes from the desire to split from an existing household either by divorce or the departure of young members.
Revamp Public Housing
Unfortunately for the Housing Authority and the government, public rental housing units operate at a recurrent loss year after year. Developing more public rental units is a big drain on public spending. Historically the cost of rental units was financed partly with cross-subsidies from the sale of HOS units. Since the HOS units are sold at a discount, the full land values are not collected. The HOS buyer pays for a fraction of the total land value and the Housing Authority holds onto the rest.
In essence, public rental housing and HOS housing in Hong Kong are partly financed through the land values of the HOS units. The monetization of such land values is not in full because part of the land premium is still unpaid and the Housing Authority retains part ownership of the HOS units. For historical reasons Hong Kong’s subsidized housing policy has evolved two kinds of housing programs: one for rent only and one for sale only. This is of course a very odd and unnecessary division. It would make good sense today to develop a single subsidized program that is available for both rent and purchase, with tenants having the option of renting first and purchasing later as in the case of Singapore’s public housing scheme.
Our low-income households would be more than willing to purchase these units if all they had to pay for was simply the full development costs plus financing the housing bureaucracy. They would be able to reap the full land values for their benefit and at nobody else’s expense. In other words there will be no unpaid land premium on the new subsidized housing units like the HOS units. The subsidized new units would all be available for rent or for purchase at an affordable price to low-income households. If our government were to adopt such an approach today, then it would be entirely feasible to finance the entire cost of subsidized housing through a full monetization of land values.
Half our present population lives in public rental housing and HOS units. If reforming the existing stock of these housing units through sales to the tenants and substantially lowering the unpaid land premiums on these units will definitely provide our ageing population with a much more reliable asset that they can hold onto in old age to finance their living and induce their children to given them the attention they always deserved and even more so with an asset to their names.
I have analyzed how such an approach can be implemented in my book entitled Long Term Housing Strategy and Homes for Hong Kong Residents, where I show the enormous political, social and economic benefits of adopting such an approach to solving the demand for low-income housing. Of course another benefit would be to end rising pressure on government’s fiscal budget. It would, in one fell swoop, remove one of the four most important growth areas of public spending entirely from the government budget.
Unbound Health Care Prometheus
Now back to health care spending. This is an unusually large growth area in Hong Kong as the baby boomer generation goes into retirement. This generation is several times larger as a fraction of the population than in any other place in the world because of the huge influx of people during the postwar years of 1945-51. This means we have hugely underinvested in medical and health care in terms of hospital infrastructure and the training of medical and health care personnel. There is a lot of catching up to do.
Fortunately Hong Kong has a high quality medical and health care sector upon which we can build up the entire industry. Investing in this industry will bring huge benefits not only to the elderly population but also the younger generation in terms of creating good economic opportunities and upward social mobility. In another two decades, as China’s population begins its own rapid ageing, medical and health care services should become one of our best exports.
Investing in our biomedical and health care industry is a no-brainer for Hong Kong and it is affordable. It should be the focus of our science and technology policy and our creativity and innovation industry strategy. Hong Kong has every reason to become a leading medical and health care center in Asia.
Hong Kong needs to act now to reap the benefits I describe here and meet the demands from our ageing population. A revised housing strategy would not only finance low-income housing, but allow for scarce public resources to be reallocated towards health care spending, part of which will be through public education investment. I also believe that adopting policies to build more hospitals, relax the admission of foreign-trained doctors into medical hospital practice here, orient our Science Park and Cyberport towards medical and healthcare research and development, and establish a separate Medical Research Council will create a strong base for fostering a medical and health care industry for Hong Kong.
Our elderly population will then receive a home they own and access to reliable quality health care. I suspect that they will become the most fervent supporters of balanced budgets, low taxes, and a free society.
YCR Wong, Long Term Housing Strategy and Homes for Hong Kong Residents, Hong Kong University Press, Hong Kong, 2014.
Fourteenth essay in the series on Rekindling Hong Kong’s Magic